Can Good Apples Be Mixed with Bad Economics? A Mengerian Critique of the Alchian and Allen Theorem

Abstract

Abstract. The Alchian and Allen Theorem has been a popular staple of many economics classes since Armen Alchian and William Allen first introduced it in their well‐known text University Economics. The Theorem says that the addition of the same fixed cost to two similar goods will result in an increase of demand for the higher‐priced, “higher‐quality” good relative to the lower‐quality item. Response to the Theorem ranges from an informal comment that it is a “parlor trick” to it being called the “Third Law of Demand.” We review some of the literature, and use Carl Menger's economic analysis to challenge the Theorem's validity. Based on Menger's analysis, we conclude that the Theorem is not, in fact, a theorem because it is does not describe a general case, but instead only applies in some cases, thereby becoming, at best, a special case of Menger's more general analysis. Further, we find evidence that Alchian and Allen themselves unwittingly contradict their own argument elsewhere in one of their texts.