The Role Of Transactions Costs In Economic Growth

  • David Bywaters
  • Pawel Mlodkowski


This paper deals with the role of reductions in transactions costs as a cause of economic growth. The core of the paper consists of three analyses of this issue. First, an intuitive analysis based on the “make versus buy” decision, relating the scope of trading to production cost differences and transactions costs. Secondly, the paper presents a quite general theoretical analysis of consumption and production activities, and of exchange activities with transactions costs, in the context of mathematical programming, to show how reductions in transactions costs affect the economic welfare and growth of an overall economy. Lastly, linear programming and duality is used to relate the earlier results more closely to GDP and economic growth.

Optimising consumption, for an agent, involves a Lagrangean function, and Lagrange multipliers for commodities, which can be interpreted as prices. An important aspect of the approach here is that each agent has their own prices, so the analysis is rather different to that of conventional demand theory. Agent-specific prices follow from significant transactions costs. The power of conventional demand theory is obtained by ignoring transactions costs, enabling prices to be equalised across agents. Consumption here is optimized where the constraint for each commodity is that goods and services can only come from stock, production, or exchange. Each agent can own and operate production processes, which are assumed to be linear. To operate a production process, an agent must “own” the required input commodities. This assumption is necessary to keep track of the associated transactions costs. Each agent can acquire some of one commodity from another agent, in exchange for giving up some of another commodity of its own, while incurring some transactions costs. The agent’s Lagrangean function is then differentiated in order to assess the effects of a reduction in transaction costs, using comparative statics. The paper ends by applying the earlier analysis to some episodes of the economic history of growth and development, and also to government policies for reducing transactions costs.

Key words

transactions costs economic growth and development comparative statics 

JEL Classification

C4 C6 E1 D9 


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Copyright information

© Japan Economic Policy Association (JEPA) 2012

Authors and Affiliations

  1. 1.UK
  2. 2.Department of Management and Social SciencesInternational IT UniversityAlmatyKazakhstan

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