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Violating purchasing power parity

Author

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  • George Alessandria
  • Joseph P. 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.

Suggested Citation

  • George Alessandria & Joseph P. Kaboski, 2004. "Violating purchasing power parity," Working Papers 04-19, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:04-19
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. 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.
    2. George Alessandria, 2005. "Consumer search, price dispersion, and international relative price volatility," Working Papers 05-9, Federal Reserve Bank of Philadelphia.
    3. Philip, Kostov, 2006. "Can the Law of One Price be tested?," MPRA Paper 628, University Library of Munich, Germany, revised 17 Jan 2006.
    4. Yilmazkuday, Hakan, 2009. "Is the Armington Elasticity Really Constant across Importers?," MPRA Paper 15954, University Library of Munich, Germany.
    5. Yu Sheng & Xinpeng Xu, 2009. "Real Exchange Rate, Productivity and Labor Market Rigidities," Working Papers 092009, Hong Kong Institute for Monetary Research.

    More about this item

    Keywords

    Purchasing power parity;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation

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