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

Chapter Six: Applications in Markets 138 Transaction costs help us understand why markets don’t appear to be as efficient as theory would suggest—they explain why prices can diverge and why these differences may last for quite some time. As mentioned, some would consider this a failure of the market. But careful reflection will show that this is not the case: failure of the market process to arbitrage out price differences shows that in fact, they are different markets. The market for strawberries in Santa Maria is an entirely different market than the market in Detroit. If you buy a strawberry in Detroit (or Denver, or Seattle) you are buying the service to produce that strawberry and deliver it at a certain place, time, and style. Considered that way, there is no generic “strawberry” market; there is only the market for the strawberries at the place, time, style, and quantity that you want to buy. We must compare “apples to apples”; a strawberry in California is not the same as a strawberry in Michigan. Consider another price difference. A soda bought at the local 24-7 convenience store will cost over one dollar, yet you can buy the same soda at less than half the price at a grocery store. These price differences stay pretty constant over time, yet again this is not a market failure—it’s a different market. With the convenience store, you are paying more for the service of having a coke conveniently available while you pump gas. The combined characteristics of the convenience store may at some times result in the best deal for you, while other times you’ll buy a case of sodas at the grocery store. Instead of criticisms over market failures, we should appreciate the creativity and diversity of services that the market can provide to meet a variety of customer needs. THE MARKET’S RESPONSE TO TRANSACTION COSTS Transaction costs tend to reduce the efficiency of the market, and allow persistent price differences to remain. But the fact that transaction costs inhibit potential gains from trade does not mean the gains aren’t there. One should expect the market to reward functions that reduce transaction costs and enable trade to occur. The middleman is a primary market actor to reduce transaction costs and facilitate exchange. It’s quite common to see middlemen berated as providing no value (since they don’t actually produce the good), and simply getting in between the producer and consumer in order to get in on the action. Yet almost all the successful businesses are actually middleman, if we think more broadly. Instead of criticisms over market failures, we should appreciate the creativity and diversity of services that the market can provide to meet a variety of customer needs. Middleman: a firm that transforms a good (or service) into a form closer to the consumer’s desired end state of a consumption good.