Markets and Transaction Costs
University of Zurich, Department of Economics, Working Paper No. 405
57 Pages Posted: 2 Apr 2022 Last revised: 27 Aug 2023
Date Written: February 11, 2022
Transaction costs are omnipresent in markets yet are often omitted in economic models.
We show that their presence can fundamentally alter incentives and welfare in markets in
which the price equates supply and demand. We categorize transaction costs into two types.
Asymptotically uninfluenceable transaction costs—such as fixed and price fees—preserve the key
asymptotic properties of markets without transaction costs, namely strategyproofness, efficiency,
and robustness to misspecified beliefs and to aggregate uncertainty. In contrast, influenceable
transaction costs—such as spread fees—lead to complex strategic behavior (which we call price
guessing) and may result in severe market failure. In our analysis of optimal design we focus on
transaction costs that are fees collected by a platform as revenue. We show how optimal design
depends on the traders’ beliefs. In particular, with common prior beliefs, any asymptotically
uninfluenceable fee schedule can be scaled to be optimal, while purely influenceable fee schedules
lead to zero revenue. Our insights extend beyond markets equalizing demand and supply.
Keywords: Transaction Costs, Markets, Demand and Supply, Incentives, Efficiency, Robustness.
JEL Classification: C72, D44, D47, D81, D82
Suggested Citation: Suggested Citation