The Alchian-Allen Theorem

The Alchian-Allen Theorem

From Wikipedia

The Alchian-Allen Theorem … states that when the prices of two substitute goods, such as high and low grades of the same product, are both increased by a fixed per-unit amount such as a transportation cost or a lump-sum tax, consumption will shift toward the higher-grade

product. This is true because the added per-unit amount decreases the relative price of the higher-grade product.

Suppose, for example, that high-grade coffee beans are $3/pound and low-grade beans $1.50/pound. Then high-grade beans cost twice as much as low-grade. But now add on a per-pound international shipping cost of $1. Now the effective prices are $4 and $2.50, so that high-grade beans cost only 1.6 times as much as low-grade. This difference will induce distant coffee-buyers to choose a higher ratio of high-to-low grade beans than local coffee-buyers.

The key point is that for the low-value product, the shipping

costs make up a greater proportion of its price – you pay more for the high-value product, but a larger fraction of your money actually goes to the product itself. So what's the application to the information age? Well, every time we buy anything, tell anybody about anything, share something wonderful we found with someone else, there is a transaction cost associated with it. The transaction costs for sharing your ideas with a wide audience used to be enormous, and you would have monks laboring to produce illuminated manuscripts of the bible, high quality versions of a high quality (by their measures) book. Then you

have the printing press, and suddenly it becomes sensible to produce newspapers. Transaction costs were brought down to the point where you didn't get a book to treasure your entire life, you got something you would read for a day and then wrap fish with. And now, with the internet, transaction costs have been brought to near-nothing. Who wants a whole newspaper these days? They used to have to bundle comics with politics with weather with want-ads with pictures of cats because of transaction costs, now we can get each of those on a separate website in bite-size emailable chunks.

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