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Understanding international prices: customers as capital

  • Lukasz A. Drozd
  • Jaromir B. Nosal

This paper develops a theory of pricing-to-market driven by marketing and bargaining frictions. Our key innovation is a capital theoretic model of marketing in which relations with customers are valuable. In our model, producers search and form long-lasting relations with their customers, and marketing helps overcome the search frictions involved in forming such matches. In the context of international business cycle patterns, the model accounts for observations that are puzzles for a large class of theories: (i) pricing-to-market, (ii) positive correlation of aggregate real export and import prices, (iii) excess volatility of the real exchange rate over the terms of trade, and (iv) low short-run and high long-run price elasticity of international trade flows. The behavior of quantities is shown to be on par with standard international business cycle theories that, in contrast to our model, assume low intrinsic elasticity of substitution between domestic and foreign goods.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 411.

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Date of creation: 2008
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Handle: RePEc:fip:fedmsr:411
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  1. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
  2. Alan C. Stockman & Linda L. Tesar, 1991. "Tastes and technology in a two-country model of the business cycle: explaining international co-movements," Working Paper 9019, Federal Reserve Bank of Cleveland.
  3. Ellen R. McGrattan & Edward C. Prescott, 2005. "Productivity and the post-1990 U.S. economy," Staff Report 350, Federal Reserve Bank of Minneapolis.
  4. Kenneth A. Froot & Paul Klemperer, 1988. "Exchange Rate Pass-Through When Market Share Matters," NBER Working Papers 2542, National Bureau of Economic Research, Inc.
  5. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2000. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," NBER Working Papers 7869, National Bureau of Economic Research, Inc.
  6. Fabio Ghironi & Marc Melitz, 2004. "International Trade and Macroeconomic Dynamics with Heterogeneous Firms," 2004 Meeting Papers 451, Society for Economic Dynamics.
  7. Susanto Basu & John G. Fernald, 1996. "Returns to scale in U.S. production: estimates and implications," International Finance Discussion Papers 546, Board of Governors of the Federal Reserve System (U.S.).
  8. Heathcote, Jonathan & Perri, Fabrizio, 2001. "Financial Globalization and Real Regionalization," Working Papers 01-05, Duke University, Department of Economics.
  9. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  10. Andrew Atkeson & Ariel Burstein, 2008. "Pricing-to-market, trade costs, and international relative prices," Staff Report 404, Federal Reserve Bank of Minneapolis.
  11. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
  12. Pinelopi K. Goldberg & Michael M. Knetter, 1996. "Goods Prices and Exchange Rates: What Have We Learned?," NBER Working Papers 5862, National Bureau of Economic Research, Inc.
  13. Heathcote, Jonathan & Perri, Fabrizio, 2002. "Financial autarky and international business cycles," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 601-627, April.
  14. Keith Head & John Ries, 2001. "Increasing Returns versus National Product Differentiation as an Explanation for the Pattern of U.S.-Canada Trade," American Economic Review, American Economic Association, vol. 91(4), pages 858-876, September.
  15. Marianne Baxter, 1995. "International Trade and Business Cycles," NBER Working Papers 5025, National Bureau of Economic Research, Inc.
  16. Egan, Mary Lou & Mody, Ashoka, 1992. "Buyer-seller links in export development," World Development, Elsevier, vol. 20(3), pages 321-334, March.
  17. Baxter, Marianne, 1995. "International trade and business cycles," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 35, pages 1801-1864 Elsevier.
  18. Reinert, Kenneth A. & Roland-Holst, David W., 1992. "Armington elasticities for United States manufacturing sectors," Journal of Policy Modeling, Elsevier, vol. 14(5), pages 631-639, October.
  19. Jonathan Eaton & Samuel Kortum, 2002. "Technology, Geography, and Trade," Econometrica, Econometric Society, vol. 70(5), pages 1741-1779, September.
  20. Kim J. Ruhl, 2008. "The International Elasticity Puzzle," Working Papers 08-30, New York University, Leonard N. Stern School of Business, Department of Economics.
  21. Paul Krugman, 1986. "Pricing to Market when the Exchange Rate Changes," NBER Working Papers 1926, National Bureau of Economic Research, Inc.
  22. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  23. Bruce A. Blonigen & Wesley W. Wilson, 1999. "Explaining Armington: What Determines Substitutability Between Home and Foreign Goods?," Canadian Journal of Economics, Canadian Economics Association, vol. 32(1), pages 1-21, February.
  24. Marston, Richard C., 1990. "Pricing to market in Japanese manufacturing," Journal of International Economics, Elsevier, vol. 29(3-4), pages 217-236, November.
  25. George Alessandria, 2004. "International Deviations From The Law Of One Price: The Role Of Search Frictions And Market Share," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(4), pages 1263-1291, November.
  26. George Alessandria, 2005. "Consumer search, price dispersion, and international relative price volatility," Working Papers 05-9, Federal Reserve Bank of Philadelphia.
  27. Pissarides, C A, 1984. "Efficient Job Rejection," Economic Journal, Royal Economic Society, vol. 94(376a), pages 97-108, Supplemen.
  28. Linda S. Goldberg & José Manuel Campa, 2010. "The Sensitivity of the CPI to Exchange Rates: Distribution Margins, Imported Inputs, and Trade Exposure," The Review of Economics and Statistics, MIT Press, vol. 92(2), pages 392-407, May.
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