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Violating purchasing power parity

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  • Geoorge Alessandria
  • Joseph Kaboski

Abstract

This paper demonstrates that deviations from the law of one price are an important source of violations of absolute PPP across countries. Using highly disaggregated U.S. export data, we document evidence of systematic international price discrimination based on the local wage of consumers in the destination market. We show that most violations from absolute PPP can also be explained by international differences in wages. We find very little additional explanation is due to differences in income per capita. Developing and calibrating a model of pricing-to-market based on search frictions and international productivity differences, we show that pricing-to-market accounts for 62 percent of the relationship between national price levels and income and 100 percent of the deviation from the law of one price. In contrast, the textbook Harrod-Balassa-Samuelson effect accounts for the remaining 38 percent of the relationship between national price levels and income.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 04-19.

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Date of creation: 2004
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Handle: RePEc:fip:fedpwp:04-19

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Keywords: Purchasing power parity;

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Citations

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Cited by:
  1. Yu Sheng & Xinpeng Xu, 2009. "Real Exchange Rate, Productivity and Labor Market Rigidities," Working Papers 092009, Hong Kong Institute for Monetary Research.
  2. George Alessandria, 2005. "Consumer search, price dispersion, and international relative price volatility," Working Papers 05-9, Federal Reserve Bank of Philadelphia.
  3. Yilmazkuday, Hakan, 2009. "Is the Armington Elasticity Really Constant across Importers?," MPRA Paper 15954, University Library of Munich, Germany.
  4. Philip, Kostov, 2006. "Can the Law of One Price be tested?," MPRA Paper 628, University Library of Munich, Germany, revised 17 Jan 2006.
  5. Alessio Emanuele BIONDO, 2010. "The Law of One Price: Survey of a Failure," Theoretical and Practical Research in Economic Fields, ASERS Publishing, ASERS Publishing, vol. 0(2), pages 168 - 182, December.
  6. Buera, Francisco J. & Kaboski, Joseph P., 2012. "Scale and the origins of structural change," Journal of Economic Theory, Elsevier, vol. 147(2), pages 684-712.

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