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Price equalization does not imply free trade

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  • Piyusha Mutreja
  • B. Ravikumar
  • Raymond Riezman
  • Michael J. Sposi

Abstract

In this paper we show that price equalization alone is not sufficient to establish that there are no barriers to international trade. There are many barrier combinations that deliver price equalization, but each combination implies a different volume of trade. Therefore, in order to make statements about trade barriers it is necessary to know the trade flows. We demonstrate this first in a simple two-country model. We then extend the result to a multi-country model with two sectors. We show that for the case of capital goods trade, barriers have to be large in order to be consistent with the observed trade flows. Our model also implies that capital goods prices look similar across countries, an implication that is consistent with data. Zero barriers to trade in capital goods will deliver price equalization in capital goods, but cannot reproduce the observed trade flows in our model.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2012-010.

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Date of creation: 2012
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Handle: RePEc:fip:fedlwp:2012-010

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Keywords: Purchasing power parity ; International trade;

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  1. Piyusha Mutreja & B. Ravikumar & Raymond Riezman & Michael Sposi, 2012. "Price equalization does not imply free trade," Globalization and Monetary Policy Institute Working Paper 129, Federal Reserve Bank of Dallas.
  2. Michael E. Waugh, 2009. "International trade and income differences," Staff Report 435, Federal Reserve Bank of Minneapolis.
  3. Chang-Tai Hsieh & Peter J. Klenow, 2007. "Relative Prices and Relative Prosperity," American Economic Review, American Economic Association, vol. 97(3), pages 562-585, June.
  4. Robert E. Hall & Charles I. Jones, 1999. "Why Do Some Countries Produce So Much More Output per Worker than Others?," NBER Working Papers 6564, National Bureau of Economic Research, Inc.
  5. Douglas Gollin, 2002. "Getting Income Shares Right," Journal of Political Economy, University of Chicago Press, vol. 110(2), pages 458-474, April.
  6. R. Dornbusch & S. Fischer & P. A. Samuelson, 1976. "Comparative Advantage, Trade and Payments in a Ricardian Model With a Continuum of Goods," Working papers 178, Massachusetts Institute of Technology (MIT), Department of Economics.
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Cited by:
  1. Piyusha Mutreja & B. Ravikumar & Raymond Riezman & Michael Sposi, 2012. "Price equalization does not imply free trade," Globalization and Monetary Policy Institute Working Paper 129, Federal Reserve Bank of Dallas.
  2. Mutreja, Piyusha & Ravikumar, B. & Sposi, Michael J., 2014. "Capital goods trade and economic development," Working Papers 2014-12, Federal Reserve Bank of St. Louis.
  3. Mutreja, Piyusha & Ravikumar, B. & Sposi, Michael J., 2014. "Capital goods trade and economic development," Globalization and Monetary Policy Institute Working Paper 183, Federal Reserve Bank of Dallas.

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