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Price equalization does not imply free trade

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Abstract

In this paper we show that price equalization alone is not sufficient to establish that there are no barriers to international trade. There are many barrier combinations that deliver price equalization, but each combination implies a different volume of trade. Therefore, in order to make statements about trade barriers it is necessary to know the trade flows. We demonstrate this first in a simple two-country model. We then extend the result to a multi-country model with two sectors. We show that for the case of capital goods trade, barriers have to be large in order to be consistent with the observed trade flows. Our model also implies that capital goods prices look similar across countries, an implication that is consistent with data. Zero barriers to trade in capital goods will deliver price equalization in capital goods, but cannot reproduce the observed trade flows in our model.

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  • Piyusha Mutreja & B. Ravikumar & Raymond Riezman & Michael Sposi, 2012. "Price equalization does not imply free trade," Working Papers 2012-010, Federal Reserve Bank of St. Louis.
    • Handle: RePEc:fip:fedlwp:2012-010
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    1. Piyusha Mutreja & B. Ravikumar & Raymond Riezman & Michael Sposi, 2015. "Price Equalization Does Not Imply Free Trade," Review, Federal Reserve Bank of St. Louis, vol. 97(4), pages 323-339.
    2. James E. Anderson & Eric van Wincoop, 2003. "Gravity with Gravitas: A Solution to the Border Puzzle," American Economic Review, American Economic Association, vol. 93(1), pages 170-192, March.
    3. Armenter, Roc & Lahiri, Amartya, 2012. "Accounting for development through investment prices," Journal of Monetary Economics, Elsevier, vol. 59(6), pages 550-564.
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    9. Chang-Tai Hsieh & Peter J. Klenow, 2007. "Relative Prices and Relative Prosperity," American Economic Review, American Economic Association, vol. 97(3), pages 562-585, June.
    10. Mutreja, Piyusha & Ravikumar, B. & Riezman, Raymond & Sposi, Michael, 2014. "Price equalization, trade flows, and barriers to trade," European Economic Review, Elsevier, vol. 70(C), pages 383-398.
    11. M. Affendy, Arip & Sim Yee, Lau & Satoru, Madono, 2010. "Commodity-industry classificationproxy: A correspondence table between SITC revision 2 and ISIC revision 3," MPRA Paper 27626, University Library of Munich, Germany.
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    1. Piyusha Mutreja & B. Ravikumar & Raymond Riezman & Michael Sposi, 2015. "Price Equalization Does Not Imply Free Trade," Review, Federal Reserve Bank of St. Louis, vol. 97(4), pages 323-339.
    2. Mark A. Wynne, 2012. "Five Years of Research on Globalization and Monetary Policy: What Have We Learned?," Annual Report, Globalization and Monetary Policy Institute, Federal Reserve Bank of Dallas, pages 2-17.
    3. Mutreja, Piyusha & Ravikumar, B. & Riezman, Raymond & Sposi, Michael, 2014. "Price equalization, trade flows, and barriers to trade," European Economic Review, Elsevier, vol. 70(C), pages 383-398.
    4. Piyusha Mutreja & B. Ravikumar & Michael Sposi, 2014. "Capital goods trade and economic development," Globalization Institute Working Papers 183, Federal Reserve Bank of Dallas.
    5. Michael Sposi, 2015. "Navigating the Structure of the Global Economy," Annual Report, Globalization and Monetary Policy Institute, Federal Reserve Bank of Dallas, pages 10-17.

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    More about this item

    Keywords

    Purchasing power parity; International trade;

    JEL classification:

    • F01 - International Economics - - General - - - Global Outlook
    • F02 - International Economics - - General - - - International Economic Order and Integration

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