Explain why price levels are lower in poorer countries
What will be an ideal response?
One theory explains the difference in prices on different endowments of capital and labor (Bhagwait, Kravis, and Lipsey). The explanation is as follows:
? Rich countries have high capital-labor ratios while poor countries have much more labor relative to capital.
? Because rich countries have high capital labor ratios, the MPL is greater and thus they have a higher wage.
? Higher wages lead to higher disposable income, and citizens' demand for goods will increase.
? Because labor is cheaper in poor countries and is used intensively in producing non-tradable goods; non-tradable goods will be cheaper in the poor countries than in the rich.
? The price of non-tradable goods will move with the increase in wage, thus increasing the price level of the good.
Rich Countries: Expensive Non-tradable goods vs. Poor Countries: Cheap Non-tradable goods.
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