Trade Costs, Pricing to Market, and International Relative Prices

Abstract

We extend some of the recently developed models of international trade to study their implications for the main features of the fluctuations in the relative producer and consumer prices of tradeable and traded goods observed in the data. We find that when our model is parameterized to match some of the main features of the data on trade volumes both at the aggregate and firm level and to have reasonable implications for both the concentration of production among producers in a market and the distribution of markups of price over marginal cost, it reproduces many of the main features of the data on the fluctuations in the relative producer and consumer prices of tradeable and traded goods. We then use this model to assess the extent to which international trade costs and imperfect competition with pricing to market play essential roles in accounting for these price data. We find that international trade costs play an essential role in our model in accounting for the behavior of both producer and consumer prices for tradeable and traded goods. We find that imperfect competition with pricing to market plays an essential role in accounting for the behavior of producer prices for tradeable and traded goods, but it plays only a minor role in accounting for the behavior of consumer prices of tradeable goods. ∗Very preliminary and incomplete. Please check the authors’ websites for more up to date versions of this paper. †We thank V.V. Chari and Marc Melitz for very useful comments and Ricardo Pasquini and Sergio Xavier for excellent research assistance. ‡UCLA, Federal Reserve Bank of Minneapolis, and NBER. §UCLA.

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