Alchian and Allen show that a per unit transactions cost lowers the relative price of, and raises the relative demand for, high‐quality goods. We extend their theory, deriving a relationship between per unit and ad valorem trade costs and the quality composition of trade. Detailed international trade data for many importers and exporters are used to test these predictions. Within a narrowly defined commodity classification, exporters charge destination‐varying prices that covary positively with shipping costs and negatively with tariffs. These results provide a clear rejection of the iceberg assumption on transportation costs and a strong confirmation of the classical Alchian‐Allen hypothesis. We show that these results cannot be explained by monopoly pricing‐to‐market behavior.
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