Question

What are transaction costs, and why do they reduce the number of trades? How have companies such as eBay (and the Internet generally) lowered transaction costs?

Answer 1

Transactions costs can be seen as those expenses which incurred while buying or selling any product or service. If we talk in terms of financial terms, it will include the commissions and spreads of brokers which can be the difference between the price which is paid by the dealer as a security and the prices paid by the buyers.

Transaction costs reduce the number of traders as with the increasing number of traders, each will be having their commissions and various other types of expenses, and thus the overall cost of the product will be quite high. Due to higher price resulting from higher transaction costs, customers will tend not to buy the product or switch to other products which are relatively cheaper.

By eliminating various intermediaries such as distributors, wholesalers, CNF agents and retailers, most of the internet based e-commerce companies have reduced transaction costs in a great deal as they would save the expenses or commission given to these intermediaries.