Alchian-Allen Theorem
Encyclopedia
The Alchian-Allen Theorem was developed in 1964 by Armen Alchian
and William R. Allen in the book University Economics (now called Exchange and Production ). It states that when the prices of two substitute good
s, 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. (Prices are illustrative only).
Another example, provided by Tyler Cowen
, is that the theorem, briefly, implies that Australians drink higher-quality Californian wine than Californians, and vice-versa, because it is only worth the transportation costs for the most expensive wine.
He also related this theorem to long-distance relationship
s.
Colloquially, the Alchian-Allen theorem is also known as the “shipping the good apples out” theorem (Thomas Borcherding) or as the “third law of demand.”
Armen Alchian
Armen Albert Alchian is an American economist and an emeritus professor of economics at the University of California, Los Angeles....
and William R. Allen in the book University Economics (now called Exchange and Production ). It states that when the prices of two substitute good
Substitute good
In economics, one way we classify goods is by examining the relationship of the demand schedules when the price of one good changes. This relationship between demand schedules leads economists to classify goods as either substitutes or complements. Substitute goods are goods which, as a result...
s, 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. (Prices are illustrative only).
Another example, provided by Tyler Cowen
Tyler Cowen
Tyler Cowen is an American economist, academic, and writer. He occupies the Holbert C. Harris Chair of economics as a professor at George Mason University and is co-author, with Alex Tabarrok, of the popular economics blog Marginal Revolution...
, is that the theorem, briefly, implies that Australians drink higher-quality Californian wine than Californians, and vice-versa, because it is only worth the transportation costs for the most expensive wine.
He also related this theorem to long-distance relationship
Long-distance relationship
A long-distance relationship is typically an intimate relationship that takes place when the partners are separated by a considerable distance....
s.
Colloquially, the Alchian-Allen theorem is also known as the “shipping the good apples out” theorem (Thomas Borcherding) or as the “third law of demand.”