Wednesday, June 19, 2013

Why is living in poor countries so cheap?

Theory tells us the law of one price should hold: the same good should have the same price throughout the world after taking into account exchange rates (and transportation costs). Yet, there is plenty of empirical evidence that this is not true. And anecdotal evidence, too, think of how it is noticeably less expensive to live in developing countries. Why?

Daniel Murphy offers a new and simple explanation: complementarity between tradable and non-tradable goods. In a rich country, more non-tradable goods are available as complements, thus providers of tradable goods can charge higher prices if competition is not perfect. This conjecture is supported by empirical evidence showing that where more complements are used the prices of tradables are also higher. But given that the extend of complementarity seems to change from one country to the other, it seems to me that we are not really talking about the same good. We may measure it as the same good, but people seem to perceive it as a different good. It is just a measurement issue.

No comments: