Jevons Paradox

An economic theory stating that as technology increases the efficiency of a resource, the demand for that resource actually rises.

The Jevons Paradox occurs when technological progress or efficiency improvements decrease the cost of using a resource, but instead of reducing consumption, the lower cost causes total demand for that resource to explode. In modern investing, this is frequently applied to technology and computing power, such as artificial intelligence and cloud computing. For investors, understanding this paradox is crucial when evaluating industries undergoing rapid price deflation. While bears might argue that falling unit prices will destroy industry revenues, the Jevons Paradox suggests that cheaper unit costs will unlock massive, previously uneconomical use cases, ultimately expanding the total addressable market (TAM) and driving higher aggregate revenues for the providers. Investors should be careful not to assume that every price drop triggers this paradox. It relies heavily on high price elasticity of demand; if a resource is already abundant and demand is saturated, further efficiency gains may simply lead to lower overall spending rather than a surge in new consumption.

In 2023, processing 1 million AI tokens cost $30, and companies used them sparingly. By 2026, efficiency gains drop the price to $0.10 per million tokens (a 300x price drop). However, because it is now so cheap, companies embed AI into every daily workflow, increasing their consumption from 10 million tokens a month to 10 billion tokens. Despite the 300x price drop, the customer's monthly spend rises from $300 to $1,000.