No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Six: Applications in Markets 135 We see very few markets where the prices are identical wherever we go. In rural areas, many prices are cheaper (farm goods, labor rates to fix most anything, etc.), while others are higher (e.g., cost of a service call from a distant central repair facility). The market’s failure to arbitrage these price differentials to zero is not something due to greedy businessmen, or a failed market process. The explanation is something called transaction costs . Transaction costs are not a market failure; they are an inescapable market feature. They explain why we never really see the ideal: where quantity supplied and quantity demanded are exactly equal at a given price (where the supply curve intersects the demand curve). Transaction costs are simply the costs of arranging trades between suppliers and demanders. These costs can be from any of a number of causes, including the list below. TRANSACTION COSTS INCLUDE: • Search and Information Costs • Transportation costs • Bargaining Costs • Enforcement Costs Figure 6.5, Arbitrage in the Fresh Strawberry Market. Theory suggests there are profit opportunities if the market price diverges from the equilibrium highlighted above. We should see some of the supply in Santa Maria be taken to Detroit, to take advantage of the price difference. This would tend to reduce the supply in Santa Maria, which increasing the supply in Detroit. This process should continue until the price is the same and there is no further opportunity for arbitrage. Yet do we see this price action in the real world? P ($) Q (#) Q * 2 D Santa Maria, CA S 1 Q (#) P ($) Detroit, MI S 1 S 2 D Q * 2 S 2 Transaction costs are simply the costs of arranging trades between suppliers and demanders. Transaction costs: the costs of arranging trades between buyers and sellers.