Understanding International Price and Consumption Disparities

This study proposes a new measure of the tradability of 120+ commodities based on price dispersion. This approach is used to construct price indices of tradables and non-tradables for 150+ countries. The expenditure share of tradables is lower for richer countries, while the relative price of non-tradables, which plays an important role in the determination of real exchange rates, is higher. Secondly, a common-factor approach (based on principal components) is introduced to compress the large volume of information on prices and quantities consumed globally. We find that cross-commodity correlations are higher for prices than for consumption. In addition, income is responsible for 98% of the variation in the first principal component of consumption but explains only 24% of the first price component. This suggests consumption are driven primarily by domestic factors, while prices are determined by factors outside the country, along the lines of the Purchasing Power Parity theory.