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Understanding International Prices: Customers as Capital

  • Jaromir B. Nosal

    (University of Minnesota)

  • Lukasz A. Drozd

    (University of Minnesota)

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 Society for Economic Dynamics in its series 2007 Meeting Papers with number 755.

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Date of creation: 2007
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Handle: RePEc:red:sed007:755
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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