Economists often refer to "the price" as if each good had only one price at a given time. But gas prices differ between service stations, and grocers commonly charge different prices for what seem to be the same foods. How can this be reconciled with economic models that arrive at a single price? The answer is that transaction costs create opportunity cost "wedges" between the various market prices for a good.

Transaction costs are the costs associated with (a) gathering information about prices and availability, and (b) mobility, or transporting goods, resources, or potential buyers between markets.

The value of the time you take reading ads and driving to a store to take advantage of a bargain is one form of transaction costs. Gasoline used and wear-and-tear on your car in gathering information and locating goods are also transaction costs. Would you knowingly drive 50 miles from store to store to save $5, or would you prefer to buy at a nearby shopping mall?

 

      Sellers would always sell at the highest possible price if transaction costs were zero, while buyers would only pay the lowest possible price. If so, the highest and lowest possible prices must be identical–only one price could exist for identical goods. Thus, at any given time, transaction costs account for ranges in the monetary prices of any single good. Paying a higher monetary price is often efficient if acquiring the good at a lower monetary price entails high transaction costs.

 

      Transaction costs also help explain why prices sometimes move erratically towards equilibrium. If information were perfect and mobility instantaneous and costless, prices would be driven to equilibrium like arrows shot at a bull's-eye by an expert archer. Instead, prices may resemble basketballs–bouncing up, down, and sideways before finally "reaching equilibrium" by going through the hoop. The speed of equilibration is negatively related to the costs of mobility and information.

 

      People search for bargains only to the extent that they expect the benefits from shopping (lower prices) to exceed the transaction costs they expect to incur. We constantly make decisions based on incomplete or inaccurate information in our uncertain world. Acquiring better market information is a costly process, as is moving goods or resources between markets. Intermediaries help minimize these transaction costs.

Asymmetric Information

Intermediation is not a flawless process that reduces transactions costs in every case.  Economists increasingly focus on problems arising from asymmetric information.

Problems of asymmetric information exist when one party to a transaction has better information than other parities, and can gain by exploiting the value of that information.

For example, a dealer might know that a car’s odometer has been altered to show low mileage, but may try to conceal this knowledge from a potential used-car buyer.  Thus, government is used to prosecute fraud that arises from asymmetric information – only one of numerous situations where government action seems necessary, even in economies based primarily on market forces.