Thursday, April 12, 2007

What is a fair transaction?

I had a very interesting discussion with a friend of mine today. I had recently purchased a used computer from a customer of mine. The objective was to resell it to somebody who needed a refurbished PC. During inspection we found that there is a reasonably good chance for the PC to fail as there were some ready-to-go-bust capacitors on the motherboard. The discussion was whether I should reveal this information to a potential buyer. My contention was that I should because I would rather be 'just' than 'rich'. We discussed about how most companies in our market tries to sell goods to us with false information or with concealed facts. The question is - What is a fair transaction?

From an economics point of view a transaction is a transfer of value from a seller to a buyer at a rate agreed upon by both. The value could be a service, a good, an opportunity, etc and henceforth we will refer to this as the object of the transaction. A person buying milk from a store, paper boy delivering paper to a customers house, a teacher teaching a class etc... are examples for transactions. All the transactions succeed an unwritten contract between the buyer and the seller in that the buyer is going to get the given value and the seller is going to get the given price.

The dictionary reference of fair is "Free from favouritism or self-interest or bias or deception; or conforming with established standards or rules". If either of the parties involved does not get what he was supposed to get, then the transaction can be considered unfair to that party. In an unfair, greedy and selfish world there is always the possibility of a person gaining unfair advantage in a transaction. Thes would mean that one of them - either the buyer or the seller gets cheated in the transaction. So what are the necessary and sufficient conditions for a fair transaction? Is a fair transactions even possible?

When a person decides to buy or sell value, he/she already has a presumed value about the object of the transaction. This presumed value is based on the information that he/she has about the object. Now if the other person involved has either more or less information than the first then there is information asymmetry. In such a situation there is a possibility for the person with the larger set of information to charge more or give less, when seller and when buyer respectively, and the other person to agree to give more or get less, when seller and when buyer respectively. So even if not intentional the transaction becomes unfair to one of the parties. If there is an intention from one of the parties then the unfairness could be amplified. One simple examples of such a situation is where people agree to buy goods at higher than normal rates because of lack of information about market prices. Another case is where people are paid less than what they deserve when they don't know about the market rates.

It is not required that both parties need to know everything about the object of the transaction. Both should have the same sets of information. Equal information alone does not ensure a fair transaction. The buyer and the seller should have similar analytical capabilities to process the given information to come to the same conclusion about the value of the transaction. Here again both should have comparable analytical powers to come to the same conclusion. It really shouldn't matter if one of them is analytically stronger than the other in other areas.

Even if both parties have the same sets of information and if both concludes the same about the value the transaction could still be biased if there is an external factor affecting the transaction. A very simple example is when a third part or a regulatory body sets rates for the transaction. In such a situation the bias will depend on the external factor and could go either way - towards the buyer or the seller. Another simple example is when a person is forced to sell his land for a lower price because he is in urgent need of money.

Thus the three necessary and sufficient conditions for a fair transaction are
a) Equal information about the transaction for both parties
b) Similar processing capability to come to the same conclusion about the value
c) Absence of external factors biasing the transaction
Theoretically it would be impossible to have a fair transaction just like it is impossible to have a perfect market. However we have ignored the ethics and value systems while explaining the logic. A person could sell an object to another person who does not about the value of the object and still sell it at the value he has perceived about it if he is a fair person. The point is that even if the theory fails we still could have fair transactions if we have a good value system in our society. So let us hope for a future where our society has a good value system.