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RESULTS OF PRODUCT-PRICE STUDIES: Theory Guiding the Data 3

Posted by Connie R. Aponte on April 23, 2014 in RESULTS OF PRODUCT-PRICE STUDIES |

It is worth emphasizing that the phrase “caused by international trade” needs to be treated carefully. As Deardorff and Haikura (1994) discuss, this phrase can be misleading in that international trade–i.e., the flows of goods and services across countries–is the endogenous outcome of (among other things) international differences in tastes, technology, endowments, and barriers to trade. International trade and product prices are simultaneously caused by things; trade does not cause product-price changes. Thus attributing causality from international trade to domestic product prices requires a bit more precise language. Specifically, it requires reference to some aspect of the international-trade equilibrium that can be plausibly taken as exogenous to domestic product prices.

Following Deardorff and Haikura, I propose four different restatements of the phrase “international trade can change domestic product prices,” each of which elaborates on “international trade.”.

• (1) “A change in domestic political barriers to trade can change domestic product prices.”

• (2) “A change in foreign political barriers to trade can change domestic product prices.”

• (3) “A change in international natural barriers to trade can change domestic product prices.”

• (4) “A change in foreign tastes, technology, and/or endowments can change domestic product prices.”

Think of domestic product prices as depending both on “international” product prices and on any trade barriers that wedge between international and domestic prices. If the country is “small” then international prices are independent of domestic trade barriers and other parameters. Otherwise, domestic trade barriers and other domestic parameters do affect international prices. Given this setup, statements (1) through (3) address how domestic prices depend on the wedge–and, if the country is large, on international prices as well. Statement (4) addresses how domestic prices depend on developments abroad communicated to the domestic economy through changes in international prices. credit

Overall, to meaningfully analyze whether “international trade changes product prices” one must have sufficient data to restate the issue something like one of these four statements. Without some data on trade barriers, tastes, technology, and endowments, actual price changes cannot be empirically linked to some exogenous aspect of international trade.

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