Price Equalization Does Not Imply Free Trade

Federal Reserve Bank of St. Louis Working Paper No. 2012-010B

31 Pages Posted: 12 Apr 2012 Last revised: 16 Jul 2015

See all articles by Piyusha Mutreja

Piyusha Mutreja

Syracuse University - Department of Economics

B. Ravikumar

Federal Reserve Bank of Saint Louis

Raymond G. Riezman

University of Iowa - Henry B. Tippie College of Business - Department of Economics; Aarhus University - Department of Economics and Business; University of California, Santa Barbara (UCSB) - Department of Economics; GEP; CESifo (Center for Economic Studies and Ifo Institute)

Michael Sposi

Southern Methodist University (SMU)

Multiple version iconThere are 3 versions of this paper

Date Written: April 1, 2012

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 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.

Keywords: Purchasing Power Parity, Capital Goods Prices, Bilateral Trade Flows, Trade Barriers

JEL Classification: F11, F21, F41

Suggested Citation

Mutreja, Piyusha and Ravikumar, B. and Riezman, Raymond G. and Sposi, Michael, Price Equalization Does Not Imply Free Trade (April 1, 2012). Federal Reserve Bank of St. Louis Working Paper No. 2012-010B. Available at SSRN: https://ssrn.com/abstract=2038592 or http://dx.doi.org/10.2139/ssrn.2038592

Piyusha Mutreja (Contact Author)

Syracuse University - Department of Economics ( email )

110 Eggers Hall
Department of Economics
Syracuse, NY 13244
United States

HOME PAGE: http://www.maxwell.syr.edu/econ/

B. Ravikumar

Federal Reserve Bank of Saint Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Raymond G. Riezman

University of Iowa - Henry B. Tippie College of Business - Department of Economics ( email )

316 PBB
Iowa City, IA 52242
United States

HOME PAGE: http://www.biz.uiowa.edu/faculty/rriezman/

Aarhus University - Department of Economics and Business ( email )

Fuglesangs Alle 4
Aarus, 8210
Denmark

HOME PAGE: http://www.biz.uiowa.edu/faculty/rriezman/

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

2127 North Hall
Santa Barbara, CA 93106
United States

GEP ( email )

University Park
Nottingham, NG7 2RD
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.cesifo.de

Michael Sposi

Southern Methodist University (SMU) ( email )

6212 Bishop Blvd.
Dallas, TX 75275
United States

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