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Why are goods and services more expensive in rich countries? demand complementarities and cross-country price differences

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  • Daniel P. Murphy

Abstract

Empirical studies show that tradable consumption goods are more expensive in rich countries. This paper proposes a simple yet novel explanation for this apparent failure of the law of one price: Consumers’ utility from tradable goods depends on their consumption of complementary goods and services. Monopolistically competitive firms charge higher prices in countries with more complementary goods and services because consumer demand is less elastic there. The paper embeds this explanation within a static Krugman (1980)-style model of international trade featuring differentiated tradable goods. Extended versions of the model can also account for the high prices of nontradable services in rich countries. The paper provides direct evidence in support of this new explanation. Using free-alongside-ship prices of U.S. and Chinese exports, I demonstrate that prices of specific subsets of tradable goods are higher in countries with high consumption of relevant complementary goods, conditional on per capita income and other country-level determinants of consumer goods prices.

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Paper provided by Federal Reserve Bank of Dallas in its series Globalization and Monetary Policy Institute Working Paper with number 156.

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Date of creation: 2013
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Handle: RePEc:fip:feddgw:156

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Keywords: Price levels ; Trade;

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  18. Nakamura, Emi & Zerom, Dawit, 2008. "Accounting for Incomplete Pass-Through," MPRA Paper 14389, University Library of Munich, Germany.
  19. David L. Hummels & Volodymyr Lugovskyy, 2008. "International pricing in a generalized model of ideal variety," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  20. Emi Nakamura & Dawit Zerom, 2010. "Accounting for Incomplete Pass-Through," Review of Economic Studies, Oxford University Press, vol. 77(3), pages 1192-1230.
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As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Why is living in poor countries so cheap?
    by Economic Logician in Economic Logic on 2013-06-19 15:14:00
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Cited by:
  1. Murphy, Daniel P., 2013. "A shopkeeper economy," Globalization and Monetary Policy Institute Working Paper 158, Federal Reserve Bank of Dallas.

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