Alchian–Allen effect

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The Alchian–Allen effect was described in 1964 by Armen Alchian and William R Allen in the book University Economics (now called Exchange and Production[1]). It 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 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; in this example, high-grade beans cost twice as much as low-grade beans. If a per-pound international shipping cost of $1 is added, the effective prices are now $4 and $2.50: High-grade beans now cost only 1.6 times as much as low-grade beans. This reduced ratio of difference will induce distant coffee-buyers to now choose a higher ratio of high-to-low grade beans than local coffee-buyers.

The effect has been studied as it applies to illegal drugs and it has been shown that the potency of marijuana increased in response to higher enforcement budgets,[2] and there was a similar effect for alcohol in the U.S. during Prohibition.[3] This effect is called iron law of prohibition.

Another example is 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.[4]

Colloquially, the Alchian–Allen theorem is also known as the “shipping the good apples out” theorem (Thomas Borcherding),[5] or as the “third law of demand.”[6]

See also[edit]


  1. ^ Alchian, Armen Albert (1983). Exchange & production: competition, coordination & control. Belmont, CA: Wadsworth Pub. Co. ISBN 0-534-01320-1.
  2. ^ Thornton, Mark (1998). "The Potency of Illegal Drugs". Journal of Drug Issues. 28 (3): 725–740. ISSN 0022-0426.
  3. ^ Thornton, Mark (1991). The Economics of Prohibition (PDF). Salt Lake City, UT: University of Utah Press.
  4. ^ "Tim Harford on long-distance relationships - Marginal REVOLUTION". 25 November 2006.
  5. ^ Borcherding, Thomas E.; Silberberg, Eugene (1978). "Shipping the Good Apples Out: The Alchian and Allen Theorem Reconsidered". Journal of Political Economy. 86 (1): 131–138. doi:10.1086/260651. JSTOR 1828763.
  6. ^ Razzolini, Laura; Shughart, William F. II; Tollison, Robert D. (2003). "On the Third Law of Demand". Economic Inquiry. 41 (2): 292–298. doi:10.1093/ei/cbg008.

Further reading[edit]

  • Ekelund, Robert B. (1992). "The Union Blockade and Demoralization of the South: Relative Prices in the Confederacy". Social Science Quarterly. 73 (4): 890–902.