Why are Goods and Services more Expensive in Rich Countries? Demand Complementarities and Cross-Country Price Differences

Daniel Murphy ()

No 636, Working Papers from Research Seminar in International Economics, University of Michigan

Abstract: Empirical studies show that tradable consumption goods are more expensive in rich countries. This paper proposes a simple yet novel explanation for this apparent failure of the law of one price: Consumers' utility from tradable goods depends on their consumption of complementary goods and services. Monopolistically competitive firms charge higher prices in countries with more complementary goods and services because consumer demand is less elastic there. The paper embeds this explanation within a static Krugman (1980)-style model of international trade featuring differentiated tradable goods. Extended versions of the model can account for the high prices of services in rich countries, as well as for several stylized facts regarding investment rates and relative prices of investment and consumption across countries. The paper provides direct evidence in support of this new explanation. Using free-alongside-ship prices of U.S. and Chinese exports, I demonstrate that prices of specific subsets of tradable goods are higher in countries with high consumption of relevant complementary goods, conditional on per capita income and other country-level determinants of consumer goods prices.

Keywords: real exchange rates; investment; demand complementarity; monopolistic competition (search for similar items in EconPapers)
JEL-codes: E22 E31 F12 F14 L11 O16 (search for similar items in EconPapers)
Pages: 62 pages
Date: 2013-02
New Economics Papers: this item is included in nep-int and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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http://www.fordschool.umich.edu/rsie/workingpapers/Papers626-650/r636.pdf

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Working Paper: Why are goods and services more expensive in rich countries? demand complementarities and cross-country price differences (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:mie:wpaper:636

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