Have You Ever?
You and your friends want to see your favorite band live in concert. The tickets are $100 each, so you save up for a few weeks to buy yours. When you can finally make your purchase, you notice that there is a small but mandatory fee to download the tickets, so you just pay it. On the day of the concert, you help your friends pay for gas and get food before the show starts. When you get home, you do the math and realize that you actually spent $150 on the concert. How did the cost get away from you?
The problem is that there's a difference between direct costs and indirect costs. Direct costs refer to the expressed price of the good or service. Indirect costs are costs that are not included in the listed price but are still involved in the purchase. For the concert, the ticket was the direct cost. The download fee, gas, and food are all indirect costs. Additionally, indirect costs also include opportunity costs, or the missed benefits of other alternatives. For example, maybe because of the extra cost of the concert, you can’t afford to go to the movies next weekend. The missed enjoyment from the movies is added to the cost of the concert.
Definition: Friction Costs
The friction cost is the total cost of a good or service, including both the direct and indirect costs, as well as non-monetary costs like time and effort.
How It Works
It is in the best interest of companies to hide the true friction cost from buyers. When online shopping, the cost of shipping is only included when the customer is already checking out. In the United States, the sales tax is not included in the item price listed on the shelf. This is because people will buy more if the price appears lower. The store is betting that once a customer has started to check out, even if the cost is higher than expected, they will buy the product anyway.
Customers aren’t the only ones that face costs - producers face them, too. Think of a factory that produces pencils. Direct costs would be the price of production materials. The wood, rubber, graphite, and metal would be direct costs along with the manufacturing equipment. Indirect costs are still necessary for a business to operate, but not to produce the product itself. For example, the factory’s rent, billboard signs, insurance policies, or security measures are all indirect costs.
Typically, the more complicated a purchase is, the higher the friction cost will be. Buying a house is the largest purchase that most adults will ever make. The average price of a home in the United States is around $226,000, but the sale price is not the final cost. The listed price doesn’t take into account closing costs, homeowners association fees, mortgage loan fees, inspection costs, and other hidden costs that increase the end price. These types of taxes and fees are the most common types of friction costs.
Solving social problems typically introduces more friction costs to citizens. For example, let’s say there was a proposal to repave all of the major roads in the United States. The true cost of the proposal would reflect the cost of the materials, workers, traffic congestion, and environmental harm. There is also the opportunity cost of not funding other important areas. If the United States chooses to repave the roads, it cannot use those tax dollars for another pressing issue like education. Friction costs are present in transactions of all sizes, from buying tickets to a concert to purchasing a home to funding government projects. So, be on the lookout for hidden friction costs and budget for them.