Shipping the Good Horses Out

The Alchian-Allen (1964) effect states that when a fixed per-unit cost is added to two substitutes, the more expensive (higher quality) one becomes relatively cheaper, and, thus, its consumption will increase. When applied to trade in vertically-differentiated goods, the importing regions demand relatively more high-quality goods. We examine how this result changes when the importing region is also endowed with the goods. We use a vertically-differentiated goods model with heterogeneous consumers in which prices are endogenously determined. We show that the importing regions with an endowment have a stronger Alchian-Allen effect than the regions that are not endowed. We use the auction data of Australian thoroughbred yearlings to empirically test our model and find consistent empirical patterns.