Income Differences and Prices of Tradables

Speaker: Ina Simonovska, UC Davis and NBER.

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 28 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 gene-rates 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 at least a half of the observed positive relationship between prices of tradables and income across a large
sample of countries.

Arranged by Department of Economics and Centre for Economic and Business Research (CEBR).