Price Equalization Does Not Imply Free Trade
Syracuse University - Department of Economics
Federal Reserve Bank of Saint Louis
Raymond G. Riezman
University of Iowa - Henry B. Tippie College of Business - Department of Economics; GEP; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Michael J. Sposi
Globalization and Monetary Policy Institute, Research Division, Federal Reserve Bank of Dallas
April 1, 2012
Federal Reserve Bank of St. Louis Working Paper No. 2012-010B
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 theoretically in a simple two-country model. We then extend the result quantitatively 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.
Number of Pages in PDF File: 31
Keywords: Purchasing Power Parity, Capital Goods Prices, Bilateral Trade Flows, Trade Barriers
JEL Classification: F11, F21, F41working papers series
Date posted: April 12, 2012 ; Last revised: June 16, 2012
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