The Alchian and Allen theorem : theory and evidence

Abstract

The Alchian and Allen theorem states that when a common per unit fee is added to the prices of high and low quality goods, the relative price of the high quality good falls, and its relative consumption increases. The theorem has been analyzed in the literature under the assumption that the prices of the goods are exogenous. This thesis presents a spatial equilibrium model that drops this restriction. The comparative statics analysis developed in this thesis does not support the theorem proposition in the general case. The theorem is then tested empirically on U.S. hard wheat exports. Transport costs, represented by ocean grain freight rates, are not found to have a significant influence on the average quality of U.S. wheat exports for the group of importing countries with a high per capita incomes that have not received U.S. export subsidies. However, transport costs are shown to be positively related with the average quality of U.S. wheat exports for the group of low-income importing countries. Additionally, it is shown that there exists an inverse relationship between the relative price of high quality wheat and the average quality of U.S. wheat exports for high-income countries.