The AI revolution will lead the economy toward two fascinating outcomes — both tied to the Jevons Paradox and the Baumol Effect.
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Jimmy the farmer found a way to produce the same amount of wheat from half the land he normally used.
Instead of farming wheat on half his fields and building something else on the rest, he sowed wheat across the entire plot — and the amount he sold at market doubled.
Farmers across the country who adopted the method began sowing wheat far more efficiently, and large quantities of wheat flooded the markets.
The price per kilogram fell, yet suddenly countless new uses for wheat emerged, and demand rose so quickly that total spending on wheat only increased.
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This process is called the Jevons Paradox, and it is a key concept in economics.
Efficiency gains in the energy sector and the semiconductor industry, for example, ultimately gave rise to new applications and enormous demand — far exceeding the original levels of consumption.
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Many villagers who witnessed the surge in wheat demand left their previous jobs and switched to growing wheat in order to earn more.
The carpenter and the cobbler who remained in the village, seeing how much Jimmy was making in the wheat industry, decided they would stay in their trades only if they were paid double — and so the wage increase in the wheat sector drove significant price increases in other occupations as well.
This is known as the Baumol Effect: the boom in one sector raises costs across traditional industries, because workers in other trades eye the salaries in the new industry and raise their own prices accordingly.
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Artificial intelligence is consuming resources at a dizzying pace, with satellite industries such as energy, semiconductors, and even cooling systems all benefiting from the sector's growth.
The rapid efficiency gains that follow this expansion will lead to a significant drop in the cost per token, and using AI will become far cheaper.
As costs fall, the range of applications for the technology will grow at a dizzying pace, and AI's market share will ultimately expand even further — the Jevons Paradox.
Rather than fearing job losses, we should recognize that becoming more efficient will allow us to produce far greater abundance — one that benefits everyone, just as the high-tech revolution did.
The price we'll pay will show up mainly in the plumber's bill — who, thanks to the Baumol Effect, will suddenly demand an unreasonable sum just to unclog our drain.
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Pictured: Microsoft's AI server farm in Wisconsin — it and facilities like it will become a fixture of the landscape for the foreseeable future.
The analysis is based on an article on the subject by Alex Danco of Andreessen Horowitz.
👋 Hi, I'm Shlomo Strauss — follow me for more content on science and technology.