Shipping the Good Apples Out: The Alchian and Allen Theorem Reconsidered

Abstract

Gould and Segall argued that the introduction of a third, composite good vitiates the Alchian and Allen (A-A) theorem that a common charge on two substitute goods leads, real income held constant, to a relative increase in the consumption of the higher to lower quality commodity. Using Hicks's third law, however, it is demonstrated that the direct substitution effect tends to dominate the interaction effect with the third good, if the two substitutes are close. Absolute changes are also investigated and some operational propositions offered with casual supporting observations. A-A's proposition is shown to be a useful price-theoretic construction, though not a direct implication of the law of demand.