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Income Differences and Prices of Tradables

  • Ina Simonovska

    (University of Minnesota)

Empirical studies find a strong positive relationship between a country’s per-capita income and price level of final tradable goods. Among alternative explanations of this observation, I focus on variable mark-ups by firms. Mark-ups that vary with destinations’ incomes are evident from a clothing manufacturer’s online catalogue featuring unit prices of identical goods sold in 24 countries. Such price discrimination on the basis of income suggests that firms exploit lower price elasticity of demand for identical goods in richer countries. In order to capture that, I introduce non-homothetic preferences in a model of trade with product differentiation and heterogeneity in firm productivity. The model helps bring theory and data closer along a key dimension: it generates positively related prices and incomes, while preserving desirable features of firm behavior and trade flows of existing frameworks. Quantitatively, the model suggests that variable mark-ups can account for as much as a third of the observed positive relationship between prices of tradables and income across a large sample of countries.

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Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 692.

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Date of creation: 2009
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Handle: RePEc:red:sed009:692
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  1. Marc J. Melitz & Gianmarco I.P. Ottaviano, 2005. "Market Size, Trade, and Productivity," NBER Working Papers 11393, National Bureau of Economic Research, Inc.
  2. Peter K. Schott, 2004. "Across-product Versus Within-product Specialization in International Trade," The Quarterly Journal of Economics, MIT Press, vol. 119(2), pages 646-677, May.
  3. Mario J. Crucini & Mototsugu Shintani, 2002. "Persistence in Law-Of-One-Price Deviations: Evidence from Micro-Data," Vanderbilt University Department of Economics Working Papers 0222, Vanderbilt University Department of Economics, revised Jul 2004.
  4. Robert C. Feenstra & Robert E. Lipsey & Haiyan Deng & Alyson C. Ma & Hengyong Mo, 2005. "World Trade Flows: 1962-2000," NBER Working Papers 11040, National Bureau of Economic Research, Inc.
  5. Jonathan Eaton & Samuel Kortum, 2002. "Technology, Geography, and Trade," Econometrica, Econometric Society, vol. 70(5), pages 1741-1779, September.
  6. George Alessandria & Joseph P. Kaboski, 2011. "Pricing-to-Market and the Failure of Absolute PPP," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(1), pages 91-127, January.
  7. Michael E. Waugh, 2010. "International Trade and Income Differences," American Economic Review, American Economic Association, vol. 100(5), pages 2093-2124, December.
  8. Costas Arkolakis, 2008. "Market Penetration Costs and Trade Dynamics," 2008 Meeting Papers 548, Society for Economic Dynamics.
  9. Costas Arkolakis & Svetlana Demidova & Peter J. Klenow & Andres Rodriguez-Clare, 2008. "Endogenous Variety and the Gains from Trade," American Economic Review, American Economic Association, vol. 98(2), pages 444-50, May.
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