Consumers incur many transaction costs in purchasing and using most products. This paper examines the effects of a reduction in such consumer transaction costs caused by market-level technological advances. Using a model in which consumers are simultaneously heterogeneous in their transaction costs and in their marginal valuations of product quality, this paper highlights two mechanisms that can cause such reductions in consumer transaction costs to lower consumer surplus and reduce consumer share of the total social surplus. Specifically, market-level technological advances reduce different consumers' transaction costs by different amounts and increase their reservation prices by different amounts, which can lead to: (i) product design changes that many current consumers do not like and (ii) homogenization in consumer reservation prices that allows a seller to extract more surplus through its pricing policy. This paper also shows that consumers may be better off with seller-induced higher consumer transaction costs. Finally, the paper shows how, depending on the nature of the quality production process, such reductions in consumer transaction costs can either lower or raise product qualities and consumer prices.
Key words: technological advances; transaction costs; consumer homogenization; product features; product pricing
History: This paper was received January 14, 2002, and was with the author 8 months for 3 revisions; processed by Sridhar Moorthy."Everything you buy costs you twice, once for the good itself, and once for the transaction." (Forbes 1996)
Transaction costs are an inevitable part of consumer purchase and consumption experiences. For almost all of the products we consume, we have to incur the monetary, time, and hassle costs of going to a store, waiting in line, making a payment, sometimes customizing the product to our own requirements before using it, sometimes learning how to use the product properly, and finally using the product itself. (1) These consumer transaction costs have two key features. First, their magnitudes can be large enough to "matter" and affect consumer choice behavior--for example, consumers with "nontechnical" backgrounds may not use a software product if its interface is not easy to use; consumers with high valuations of time may not visit an Internet business that has slow access speed, and so forth. (2) Second, these consumer transaction costs can reduce due to market-level technological developments--for example, developments in graphical interface systems have reduced consumer learning and memorization costs involved in using computer operating systems and programming languages. This paper focuses on reductions in consumer transaction costs caused by such market-level advances and asks the following two main questions: (i) Can a consumer become worse off from such a reduction in its transaction cost and (ii) can such reductions in consumer transaction costs lower the consumer share of the total social surplus? As secondary questions, we enquire about the effect of this reduction in consumers' transaction costs on seller's profitability, about a seller's incentive to invest in such market-level technological advances, and about the direction of change in product qualities and prices.
To examine these questions, we construct a simple model in which a seller...