Market Learning Costs
By Daniel O'Connor of Integral Ventures, LLC
This discussion of psychic and search costs also relates to my theory of Market Learning via Ronald Coase's highly-regarded theory of transaction cost, which he defined quite simply as "the cost of carrying out a transaction by means of an exchange on the open market." (The Firm, The Market, and The Law, p. 6)
"In order to carry out a market transaction it is necessary to discover who it is one wishes to deal with, to inform people that one wishes to deal and on what terms, to conduct negotiations leading up to a bargain, to draw up the contract, to undertake the inspection needed to make sure that the terms of the contract are being observed, and so on. These operations are often extremely costly, sufficiently costly at any rate to prevent many transactions that would be carried out in a world in which the pricing system worked without cost.â (FML, p. 114)
The notion of transaction cost is so very sensible to educated non-economists that it probably comes as quite a surprise to learn that it was actually a controversial breakthrough among orthodox neo-classical economists--many of whom, it must be said, still adhere to a paradigm of constrained optimization in which transaction costs are presumed to be zero. Nevertheless, as Coase has been patiently teaching us for decades, a market in which transaction costs are presumed to be zero is no market at all:
"Markets are institutions that exist to facilitate exchange, that is, they exist in order to reduce the cost of carrying out exchange transactions. In an economic theory which assumes that transaction costs are nonexistent, markets have no function to perform, and it seems perfectly reasonable to develop the theory of exchange by an elaborate analysis of individuals exchanging nuts for apples on the edge of the forest or some similar fanciful example. This analysis certainly shows why there is a gain from trade, but it fails to deal with the factors which determine how much trade there is or what goods are traded. And when economists do speak of market structure, it has nothing to do with the market as an institution but refers to such things as the number of firms, product differentiation, and the like, the influence of the social institutions which facilitate exchange being completely ignored." (FML, pp. 6-8)
Also ignored, if I may add, are the personal psychology and cultural norms--the cognitive, affective, and moral structures of consciousness--expressed by market participants in their every exchange.
This begs the question, then, of how the Coasian theory of transaction cost relates to my theory of Market Learning.
During many decades of research and development, Coase and his colleagues identified several distinct types of transaction costs, culminating in Carl Dahlman's typology: (FML, p. 6)
- search and information costs
- bargaining and decision costs
- policing and enforcement costs
Notice the striking alignment between this transaction cost typology and the principles of Market Learning: the mutual pursuit of transparency, choice, and accountability.
Recall that Market Learning was originally constructed through the integration of two practical theories:
Market Exchange based on the principles of fair market value whereby market participants:
- disclose and acquire all the relevant information pertaining to the exchange;
- choose freely whether or not to engage in the exchange; and
- comply with the ultimate terms of the exchange.
Social Learning based on the principles of action science, whereby effective communication is governed by:
- valid information;
- free and informed choice; and
- internal commitment to the choice and constant monitoring of its implementation in order to detect and correct error.
By incorporating transaction cost economics into the theory of Market Learning, we have a way to discuss in terms familiar to all economists the very real practical costs associated with Market Learning--the costs incurred in pursuit of mutually agreed-upon levels of transparency, choice, and accountability.
These Market Learning costs help to explain why market participants have such a difficult time engaging in first-order and second-order Market Learning and why, in the context of the stable instability of our global economy, people continue to make market decisions that, in hindsight at least, may turn out to have been foolish, deceptive, and unsustainable.
Such an integration also reveals a variety of exciting applications for the Market Learning paradigm within the traditional domain of transaction cost economics, including the theory of the firm and the problem of social cost--both of which I will discuss in subsequent posts.
Overall, Market Learning extends what I take to be one of Coase's primary goals: to ground our theory of the market in the real world.
© 2005 by Daniel J. O'Connor. All Rights Reserved.
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