Remembering Alchian Through His Ideas, or A Review of the Alchian-Allen Theorem

Armen Alchian passed away earlier this week and in reading some of the remembrances, I came across this review of the Alchian-Allen Theorem, which I have posted the pertinent parts:

The AlchianAllen Theorem is a lesser known but still very interesting economic theory. It states that when a fixed cost is added to substitute goods, the more expensive one becomes relatively less expensive, and so people are likely to increase consumption of the higher quality good. I think the best way to illustrate the theorem is with examples.

When a drug is outlawed, people face a large fixed cost equal to the expected punishment. They not only have to pay higher money prices, but they also pay in the form of a potential prison sentence. Thus, in areas where alcohol is outlawed, people tend to drink either high concentration or high quality alcohol. It’s simply not worth the trouble to smuggle regular beer. Likewise, the THC content of marijuana has increased as more effort is spent trying to eliminate marijuana use. Paradoxically, because of the higher dosages, drug prohibition can actually increase the dangers associated with drug consumption by eliminating the low cost low concentration doses from the market.

The Alchian-Allen Theorem has profound explanatory power when applied to the internet. The harder it is to gain access to cultural elements, the higher the quality of those elements will be consumed. On the flip side, if it is easy to access culture, people will prefer to consume shorter lower quality pieces of culture. In the middle ages, people had to travel long distances to view concerts, which were performed by live musicians. Thus, the fixed costs of consumption were very high. If you bothered to pay a huge amount of money and time, you might as well view a long complex opera or symphony. On the flip side, when fixed costs are as low as a Google search, people prefer short YouTube videos of cats doing cute things. Don’t think that this means that the quality of culture has gone down.

When there are large fixed costs, an opera is only about 50% more expensive than watching a cat video. An opera would only have to bring a little more enjoyment to be worth doing.