The Gravity of Unit Prices

Within finely-defined product categories, rich countries import and export varieties at higher unit prices. While these patterns suggest that rich and poor countries consume and produce different goods, we argue that unit prices are not informative about how income per capita influences the welfare effects of international trade shocks. The standard explanation for patterns of unit prices uses only one dimension of quality: Rich importers buy more expensive higher-quality goods, and rich exporters specialize in these goods. We show that this argument cannot explain the data—not even qualitatively. We develop a model with two dimensions of quality: One that is disproportionately valued by rich consumers, and one that is equally valued by everyone. The model explains data on unit prices very well, and it delivers a gravity equation for trade flows so that the welfare effects of foreign shocks follow Arkolakis, Costinot, Rodriguez-Clare (2012). Model parameters are recovered from data through simple OLS regressions. We present two extensions of the model. First, we allow for per-unit trade cost to rationalize the increasing relationship between unit prices and distance. Second, the model remains tractable when we introduce heterogeneity across sectors in the relationship between unit prices, and importer and exporter per capita income.