Can Firms’ Location Decisions Counteract the Balassa-Samuelson Effect?
This paper studies determinants of relative price levels in a New Trade framework. The model combines a Balassa-Samuelson mechanism, explaining Purchasing Power Parity (PPP) deviations in the non-traded good sector, and an endogenous location of firms leading to PPP deviations in the traded good sector. Calibrating the model with OECD data, I show that PPP deviations in the traded good sector can either lessen or strengthen the Balassa-Samuelson effect, depending on the share of traded goods in consumption. Moreover, in general equilibrium, the real exchange rate also depends on the relative size of countries, through the Home Market Effect.
Long-Run Real Exchange Rate; PPP deviations; Balassa-Samuelson effect; location decisions; relocation; international trade; new trade theory
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