Technological advances, transaction costs, and consumer welfare

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.