Friction Cost
Categories: Trading
A trip to Italy? Getting a job as an astrophysicist? Want to live completely off of interest? What do all of these questions have in common? They are all things that might sound nice, but they all come with high friction costs (which is why so few people do them).
A fiction cost is the cost of a financial transaction. Many economic models assume no friction cost, which can be problematic since there are almost always friction costs in real life. For instance, entering and exiting a market as a firm (i.e. starting a restaurant) has friction costs, but “perfect competition” assumes no barrier to enter or exit a market, effectively ignoring real-life friction costs.
Investors must take into account things like management fees as friction costs before deciding to invest in something. Even something as already-expensive as a mortgage has friction costs (think: closing costs).
Friction costs are also present on a wider, societal scale. For instance, implementing any government regulation requires (or rather, introduces more) friction costs. We can all relate to the friction cost of taxes...wouldn’t it be nice if taxes were automatic and easy? When the government steps in to try to fix social issues, economic deadweight loss is a friction cost that the government has decided is worth it.