A Model of International Cities: Implications for Real Exchange Rates
We develop a model of international cities with each city inhabited by two representative agents, one specializing in manufacturing,ther other in distribution. Using a panel of micro=prices at the city level, we decompose the long-run cross-sectional variance of LOP deviations into the fraction due to distribution costs, trade costs anda residual. For the median good, we find trade costs account for 50 percent of the variance of real exchange rates.
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