Transaction Costs: Economies of Scale, Optimum, Equilibrium and Efficiency

TL;DR

This paper develops a game theory model to analyze transaction costs, demonstrating how costs influence optimal points, equilibrium, and sharing rules, with implications for institutional design and policy.

Contribution

It introduces a core game theory framework for transaction costs, showing how costs affect optimality, equilibrium, and sharing rules, and discusses policy implications.

Findings

Existence of an optimal transaction cost point is proven.

Exposure influences the location of the optimal transaction costs.

Transaction cost sharing rules can lead to multiple solutions.

Abstract

The aim of this article is to propose a core game theory model of transaction costs wherein it is indicated how direct costs determine the probability of loss and subsequent transaction costs. The existence of optimum is proven, and the way in which exposure influences the location of the optimum is demonstrated. The decisions are described as a two-player game and it is discussed how the transaction cost sharing rule determines whether the optimum point of transaction costs is the same as the equilibrium of the game. A game modelling dispute between actors regarding changing the share of transaction costs to be paid by each party is also presented. Requirements of efficient transaction cost sharing rules are defined, and it is posited that a solution exists which is not unique. Policy conclusions are also devised based on principles of design of institutions to influence the nature of transaction costs.