Frictionless economy is the new concept emerged from late 90s1. Its core idea is to remove the time both suppliers and customers spend on the trial and error on the price. So the markets always perform on the equilibriums. So markets can work in the perfect efficiency. But due to the various reasons, frictionless economy is rarely seen in the real world. The most common reason is lack of information. In last decade, the rise of internet and wide uses of IT technologies within businesses made the collection of information to be easier. Such trend renews people’s interesting on the frictionless economy. In this paper, we examine how exactly frictionless economy works and various reasons to prevent it to happen. We also suggest several solutions allow people to implement the frictionless economy in the real world if the only reason prevent them to have it is lack of information.frictionless economy, equilibrium, perfect efficiency, online surveys, single item auction, selling data analysis, local equilibrium and global equilibrium

Yang, Yu

English

Research Papers in Economics

  1
Frictionless Economy and Its Implementation in Real World 
 
Abstract 
 
    Frictionless economy is the new concept emerged from late 90s
1. Its core idea is to remove 
the time both suppliers and customers spend on the trial and error on the price. So the 
markets always perform on the equilibriums. So markets can work in the perfect efficiency. 
But due to the various reasons, frictionless economy is rarely seen in the real world. The 
most common reason is lack of information. In last decade, the rise of internet and wide uses 
of IT technologies within businesses made the collection of information to be easier. Such 
trend renews people’s interesting on the frictionless economy. In this paper, we examine how 
exactly frictionless economy works and various reasons to prevent it to happen. We also 
suggest several solutions allow people to implement the frictionless economy in the real 
world if the only reason prevent them to have it is lack of information. 
Keywords: frictionless economy, equilibrium, perfect efficiency, online surveys, single item 
auction, selling data analysis, local equilibrium and global equilibrium. 
 
1. Introduction 
 
    In classical supply and demand theorem, when amount of supply and demand does not 
match with each other, then both suppliers and customers need to make adjustments, so 
market can reach equilibrium. Such adjustments usually take time. In real market, such time 
can range from few weeks to one year. The Figure 1 shows typical adjustments in a market. 
At beginning, customers are at point A. The suppliers are at point B. So there is an 
oversupply in the market. So suppliers need to cut the price. So there will be more customers 
to buy the products. In the real market, one price drop usually does not solve the oversupply. 
So instead reaching equilibrium point C, both suppliers and customers should only move to 
some point in right of C. It may need suppliers to make several price drops before market 
reach equilibrium.  
 
Figure 1   2
 
 
 
2. How frictionless economy works  
 
    Beside time spent by both suppliers and customers on trial and error, there are costs
2 
associated with such adjustments, for example, customers pay higher prices on products than 
the ones they should pay. In the other hand, suppliers may sell products on a lower price than 
one they should sell. So letting both supplier and customers to take time to make adjustments 
before reaching equilibrium is not efficient way of running market. In order to let market run 
efficiently, it is good to remove time for such adjustments. For example, the night before a 
company release a product, it invites all potential customers to participate an online survey. 
From that survey, the company is able to get a supply and demand graph which contains the 
equilibrium point. Equilibrium point is the most important information on that graph. How 
both suppliers and customers reach that equilibrium point is less important. So company keep 
the equilibrium point while remove all other part of graph. See Figure 2. 
 
Figure 2   3
 
 
The above graph look unrealistic simple, but it shows what really matters to market. In the 
next day, the company just uses the price in the equilibrium to sell the products. All products 
will be sold out and no customer is unable to purchase the product.  
 
    In classical supply and demand theorem, when there is a shift in either supply or demand 
curve, then both suppliers and customers need to make adjustments, so market can reach new 
equilibrium. Such adjustments also take time. The Figure 3 shows typical adjustments in a 
market for this situation. At beginning, the market is in the equilibrium point C1. If there is a 
shift in the supply curve due to the reason such as “oil shock”, then immediately after the 
shift, customers are still in C1 but suppliers fall to point B. So there is a shortage occur in the 
market. So suppliers take this advantage and increase the price. In the real market, suppliers 
usually take the trial and error approach when they are increasing the price since there is 
always a risk for overshooting the price. So they are likely to raise the price step by step. For 
first price increase, instead reaching new equilibrium point C2, both suppliers and customers 
should only move to some point before C2. It may need suppliers to increase price several 
times before market reach new equilibrium.   4
 
Figure 3 
 
 
    So letting both suppliers and customers to take time to make adjustments before reaching 
new equilibrium is not efficient way to handle curve shift. In order to let market running 
efficiently, it is good to remove time for such adjustment. For example, immediately after the 
shift, suppliers invite all potential customers to participate an online survey. From that 
survey, the company is able to get a new supply and demand graph which contains the new 
equilibrium point. New equilibrium point is the most important information on that graph. 
How both suppliers and customers reach that new equilibrium point is less important. So 
company keep the equilibrium point while remove all other part of graph. See Figure 4 (note, 
the old equilibrium point is still marked in order to show what will happen to the frictionless 
market before and after the “oil shock”.) 
 
Figure 4   5
 
 
Again the above graph looks unrealistic simple. In the next day, the suppliers just use the 
price in the new equilibrium point to sell the products. All products will be sold out and no 
customer is unable to purchase the product.  
 
 
3. The reasons that prevent the frictionless market to happen 
 
    In the real world, it is very rare for a market to become frictionless. There are several 
reasons that prevent the frictionless market to happen.  
 
2.1 Unable to find all information needed
3 
 
    This is the most common reason that prevents market to become frictionless. Suppliers 
usually do not share the information on how many product they want to sell for a particular 
price. Thus no one can generate an aggregated supply curve. For the customer, they are 
thousands times more than suppliers. So it will be more difficult to generate an aggregated   6
demand curve. Since there is no way to generate an aggregated supply curve the demand 
curve. So it is impossible to determine the equilibrium point. 
 
2.2 Lack capacities to reach the equilibrium position 
 
    Sometimes, a company may underestimate the popularity of a product. They do not make 
enough products for initial shipment. And initial shipment was sold out very quickly. When 
they try to make the second shipment, it takes time to wait the component suppliers to supply 
the components they need. The waiting time can range from weeks to months. During this 
time, the price will be the same as the one for the initial shipment. 
 
2.3 The distance between buyer and seller
4 
 
    In some cases, the seller simply can not sell their products and services to buyer. For 
example, every year, United States allows nurses in other country to work in their hospitals. 
Between the hospitals of United States and the nurses of a foreign country, there is supply 
and demand curve. There is an equilibrium point on the curve. The problem is that US 
government imposes the quota on the number of nurses that foreign country can enter US. So 
that foreign country simply can not provide enough nurses who match to the number 
specified at the equilibrium due to this restriction. 
 
3. How to implement frictionless economy in the real world 
 
    Due to above reasons, it is very rare for a market to become frictionless. If the reasons for 
a market not to reach equilibrium are No 2 or 3, the solutions are usually not easy. But if the 
reason for a market not to reach equilibrium is just No 1, then the solutions can be easy. 
These solutions do not let a market to be absolutely frictionless, but they will let the market 
to be very closer to frictionless. There are three possible solutions to let a market to be closer 
to frictionless if only reason No 1 prevents it to happen.  
 
3.1 Uses surveys to determine equilibrium price   7
 
    Many companies usually use surveys to determine equilibrium price for their products. 
These surveys can be done before release of product or during the middle of product release. 
The surveys can be done either online or offline. The surveys usually contains the questions 
such as if the price of this product is X, how many items do you want to buy or if the price of 
this product is X, will you buy this product. If a person’s answers to these questions are 
greater than 0 or yes, he or she will be asked same questions again with a higher price of X. 
The questions are repeated until the person gives answer 0 or no. Then company who makes 
this survey summarize the demand of people for each price level for this product, then 
convert the result into the percentage, that is, what percentage of people want to buy this 
product for each price level. Then based on the population of the market they want to release 
the product and the percentage of people want to buy this product for each price level, they 
can construct the demand curve for their product which shows the number of people want to 
buy this product for each price level by multiplying population with percentage. Since they 
have supply curve in their hand, then they should be able to construct the supply and demand 
graph for their product and determine the equilibrium price.    
 
3.2 Let bidders to show the highest prices during the single item auction
5 
 
    For the single item auction, the supplier, who is the owner of item, usually has a minimum 
price for his or her item. The owner can sell the item for any price equal or greater than the 
minimum price. For demanders, they keep bidding on the item until some one come out a 
price which only that person want to pay. So the typical supply and demand graph for the 
single item auction can be: 
 
Figure 5   8
 
 
From the graph, you can see that equilibrium price can fall anywhere above the minimum 
price which supplier wants for his or her item. So from the view point of supplier, the 
equilibrium price does not have any specialty. But from the view point of demanders, the 
equilibrium price must be the highest price they can afford. So in order to determine the 
equilibrium price in the single item auction, just letting bidders to show the highest price they 
want to pay. The highest price among these highest prices should be very closer to the 
equilibrium price. In real market, some bidders may change mind and decide to increase his 
or her highest price to overtake the current highest price. But after two or three rounds, then 
there usually no one decide to increase his or her highest price to overtake the current highest 
price. The market reaches equilibrium very fast, so the market is frictionless.  
 
3.3 Collects sales data 
 
    For the small shops in the city, doing an online survey to determine the equilibrium price 
of a product is too costly for them. A good practical way to determine the equilibrium price 
for a product is to collect the selling data on that product for consecutive days after the 
product is put on the shelf. The number of days should not be long since we want to know the   9
equilibrium price fast and sell the product at the equilibrium price. The maximum length 
should be about 5 days. Each day, the price of product has a small increment or decrement 
over the yesterday’s price. The rule to do decide whether it is an increment or decrement is 
simple. If the number of purchases of yesterday is great or equal to the number of purchases 
of the day before yesterday, then it is an increment. Otherwise, it is a decrement. The amount 
of increment or decrement can be varied and does not have to be same. When deciding the 
amount of decrement of increment, there are two things need to consider. First, the amount 
has to be small. Second, the resultant price should not repeat the price of a previous day. The 
store then records the selling volume for that particular price. After collecting these data, then 
store can construct a demand curve for this product by interpolate them. The linear fit is the 
easiest and safest approach. The easiest linear fit method is Ordinary Least Square. For 
example, the followings are the selling data of a store collected for product A within 5 days 
of period.  
 
Day  Price  Purchase 
1  15  39 
2  15.25  39 
3  15.5  36 
4  15.4  37 
5  15.45  38 
 
To apply Ordinary Least Square, we set up the following three matrices.  
 
 
 
The second column of matrix X is the prices of 5 days. The matrix c is the unknown 
coefficients we need to solve in order to get the linear function we need for linear fit. The   10
matrix y is the numbers of purchases of 5 days. Then we set up the equation is Xc=y which 
is: 
 
 
Then we multiply both sides by X
T, we get X
TXc=X
Ty. The result equation is 
 
 
 
Solve the above equation, we get c0=115.81 and c1=-5.092. So the linear function is 
y=115.81-5.092x which represents the demand curve.  
 
    To construct the supply curve, we also use the easiest approach which is the other linear 
function. First, the store needs to determine the minimum price they can sell the product A 
and how many items they want to supply for this price. Second, the store needs to determine 
the maximum price they can sell the product A and how many items they want to supply for 
this price. The linear function we construct should contain two points which are (minprice, 
minsupply) and (maxprice, maxsupply). Constructing these two points from these two points 
are straightforward. For example, the store can sell the product A at the minimum price of 
12.5. At this price, they want to supply 30 items. And the store can sell the product A at the 
maximum price of 17.5. At this price, they want to supply 45 items. So c0 of the linear 
function we are going to construct should have a slope (45-30)/(17.5-12.5)=3 which is c0. 
And c1 should be 30-12.5*3=-7.5. So the linear equation represent the y=-7.5+3x. The Figure 
6 displays both supply curve and demand curve. 
 
Figure 6 
   11
demand vs. supply
0
10
20
30
40
50
60
12.5 13 13.5 14 14.5 15 15.5 16 16.5 17 17.5
price
q
u
a
n
t
i
t
y
supply
demand
 
 
    To find the equilibrium price, we just need to solve the equation 115.81-5.092x=-7.5+3x. 
The x is 15.238. Or the equilibrium price is $15.238. To make the price we put on the shelf to 
be attractive, we choose $15.23. At this price, the store should supply -7.5+3*15.23=38.19 
items or 38 items. In case that the equilibrium price do not fall between the minimum price or 
maximum price, it means that store made incorrect evaluations on minimum price, minimum 
supply amount, maximum price, or maximum supply demand. One of these values or more 
are just way off from what the selling data collected by store may suggest. So in this case, the 
store needs to revaluate these values, then find the linear equation of supply curve and 
equilibrium price again. The equilibrium price found by this store should be called local 
equilibrium which is the price in which demand of customers visiting this store is equal to 
supply of this store. If we find the enough local equilibriums, e.g., all stores of Unites States, 
then we find the average of these local equilibriums. Then result should be very close to the 
global equilibrium which is the price in which demand of customers in overall market is 
equal to supply of overall market. In most cases, the global equilibrium has little significance 
to the local stores. Because what they face are just local markets, so only local equilibriums   12
matter. The method I mentioned above can be implemented in inventory management 
software. 
 
Conclusion 
 
    In generally speaking, frictionless market is not just a fictional concept. Lacking the 
information is the most common reason which prevents the market to reach frictionless. The 
By using some practical ways, such obstacle can be removed, then any market can become 
very closer to frictionless. As the markets approach frictionless, its efficiency increases 
greatly. Such markets can benefit both consumers and suppliers. In most case, the costs for 
markets to reach frictionless are usually minimal comparing to the benefits. With the aids of 
compute technologies, many required works can be done automatically. If all markets can 
behave in frictionless way, it will fundamentally change the landscape of business world. 
 
Reference 
 
1. J. H. Cochrane, “A Frictionless view of U.S. inflation,” NBER Macroeconomics Annual, 
Vol. 13, 1998. 
2. I. H. Horn and C. Terwiesch, “Measuring the frictional costs of online transactions: the 
case of a Name-Your-Own-Price channel,” Management Science, Vol. 49, Nov. 2003, pp. 
1563-1579. 
3. W. H. Golove and J. H. Eto, “Market barriers to energy efficiency: A critical reappraisal of 
the rationale for public policies to promote energy efficiency," Office of Utility Technologies 
of the U.S. Department of Energy, Mar 1996. 
4. A. Hortascu, A. M. Jerez, and J. Douglas, “The geography of trade on eBay and 
MercadoLibre,” NET Institute Working Paper #06-09, Sep. 2006. 
5. S. Klaue, K. Kurbel, and l. Loutchko, “Automated negotiation on agent-based e-
Marketplaces: an overview,” 14th Bled Electronic Commerce Conference, Jun. 2001.  

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Frictionless economy and its implementation in real world

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