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## Alchian-Allen and Big Box Stores

A simple presentation of the Alchian-Allen theorem is that if you take two goods with different prices and you add a fixed cost to each of them, then the “more expensive” good becomes relatively less expensive. Here is a simple illustration:

Suppose we have two types of booze: White Lightning Bourbon, which costs \$8.00 per fifth, and Makers’ Mark Bourbon, which cost \$32.00 per fifth. The relative price of the good stuff is 4 times the cost of the bad stuff. In other words, each bottle of Makers’ you consume requires that you give up the chance to consume 4 bottles of the moonshine. In this world, it would not be implausible to see that the owners of Makers’ Mark would support a fixed, per bottle liquor tax on all hard liquor, nor would it be implausible for them to support all other types of interventions that add costs to all bottles of booze. For example, suppose a new rule was passed requiring costly FDA inspection of the facilities of all booze makers – and that this inspection cost \$8.00 per bottle of liquor. Or suppose that all liquor companies needed to pay for licenses that amounted to \$16 per bottle of liquor sold.  What would happen in the liquor market?

Well, if we add the \$8.00 per bottle inspection and the \$16 per bottle license fee, then the effective price of a White Lightning fifth would be \$32 and the price of Makers’ would be \$56. Both are more expensive – so you might expect (rightly) that the consumption of bourbon would fall overall. However, for customers thinking about what bourbon to purchase, notice how the relative price of Makers has fallen substantially. Now, when I purchase a fifth of Makers, I am only giving up the chance to drink 1.75 fifths of the moonshine. So I am much more likely to purchase Makers over White Lightning today than I was in the past.

This illustrates another reason why big corporations are often in favor of certain types of taxes and regulations. Given their large scale and size, they are better able to handle the burden of these regulations (i.e. they can spread these fixed costs over a larger range of output) and it puts their more expensive products in a better competitive position. This should help you understand another reason why “big box” stores are increasingly prevalent and national chains are displacing mom and pops. No doubt part of that trend reflects the tastes of the median American, but no doubt another serious part of the trend is that major corporations are better able to handle the regulatory, legal and fiscal costs of big government than their formerly smaller and more nimble competitors. Consider the story of what one person must do in order to open up a low-cost barber shop in a poor area in California (the rest of this is from RW Grant’s Incredible Bread Machine).

You might suppose that all you need to do is to practice on some friends and family, buy a pair of \$50 clippers, a chair, a few combs and antiseptics and find some willing customers and just have at it. If you were good and served your neighbors well, you would grow and prosper – as would your customers. You might even open up a bigger shop and hire a few people to help you. But here is what you must do in the state of California (and other states) in this “free market paradise of America.”

1. Secure a Barber’s License which is granted by the state Board of Barber Examiners.
2. But to get that license you must first spend two years as an apprentice working for someone else …
3. … or spend 1,500 hours at a (state-licensed of course) barber school at a cost of \$3,500.
4. Pay \$50 to register for the state test.
5. If you pass the test, pay \$50 more for a two-year license.
6. Your new shop must then be inspected and approved by the Board for another \$50.
7. Not done yet! After all this, you need, of course, to obtain a “city-business” license. If you are in a poor section of LA, this cost (15 years ago) \$106.43..
8. If you managed to get this far then your new shop would be subject to periodic snooping not only by the Barber’s Board, but also by the city health department.
9. Then, if you manage to earn any money, you must pay federal and state business taxes promptly.

But this was all for a guy opening the shop up on his own. What would have to happen for this entrepreneur to become the “engine of job creation” that he is so often celebrated for being? Suppose he wished to hire an assistant.

1. Deductions, contributions and fees must be accurately computed and paid. These include Worker’s Compensation and unemployment insurance (back then it was 1.3% on first \$7,000 in wages) and paid for by the barber/entrepreneur.
2. Then in California, you must pay the “Employee Training Tax,” of 0.1% of the first \$7,000 of income.
3. Then there is a Federal Unemployment Tax of \$56 per year per employee.

The paperwork and administrative aspect of all this represents a severe burden even to people with a good amount of schooling. How would this affect someone with poor schooling or only passing familiarity with bookkeeping? The burden would be overwhelming.  But then there is even more beyond this! Most states impose  and enforce minimum price schedules. But a poverty area shop forced to charge inflated rates would go out of business faster than it could fill out a Workers’ Comp form.

### 2 Responses to “Alchian-Allen and Big Box Stores”

hat tip “price of everything”

2. Harry says:

My present barber is a woman, who works in a salon in East Greenville, but my former barber cut my hair before he had health problems, and we had many conversations about the Pennsylvania Board of Liscencing and Inspection, or whatever you might call it.

To my horror, I learned that my barber had to pay a fee to keep his business open — I believe it was at least several hundred dollars annually. The inspector would come in every three years or so to measure the size of the room, and do whatever else he had to do, which I assume had to be inspecting the hairs on the floor. No fooling.

Over the years I think I convinced my complaisant barber that this was an outrage.

Some would argue that the fees pay for the inspectors, but never mind. Why do we have people on the public payroll, who may get public pensions and post-retirement health benefits, to measure the square feet in barbershops?

Even if Sweeney Todd were in business in Altoona, screw the barbershop inspectors.

Thanks for the effort in your illuminating article, WCow.