International macroe.. - Free

286CHAPTER 9. THE NEW INTERNATIONAL MACROECONOMICS9.2 Pricing to MarketThe integration of international commodity markets in the Redux modelrules out deviations from the law-of-one price in equilibrium. Were suchviolations to occur, they presumably would induce consumers to takeadvantage of international price differences by crossing the border tobuy the goods (or contracting with foreign consumers to do the shoppingfor them) in the lower price country resulting in the internationalprice differences being bid away.We will now modify the Redux model by assuming that domesticand foreign goods markets are segmented. Domestic (foreign) agents areunable to buy the domestically-produced good in the foreign (home)country. The monopolistically competitive Þrm has the ability to engagein price discrimination by setting a dollar price for domestic salesthat differs from the price it sets for exports. This is called pricing-tomarket.For concreteness, let the home country be the ‘US’ and the foreigncountry be ‘Europe.’ We assume that all domestic Þrms have the abilityto price-to-market as do all foreign Þrms. This is called ‘full’ pricingto-market.Betts and Devereux [10] allow the degree of pricing-tomarket–thefraction of Þrms that operate in internationally segmentedmarkets–to vary from 0 to 1. Both the Redux model and the nextmodel that we study are nested within their framework. The associatednotation is summarized in Table 9.2.Full Pricing-To-MarketWe modify Redux in two ways. The Þrst difference lies in the pricesettingopportunities for monopolistically competitive Þrms. The goodsmarket is integrated within the home country and within the foreigncountry, but not internationally. The second modiÞcation is in themenu of assets available to agents. Here, the internationally tradedasset is a nominal bond denominated in ‘dollars.’ The model is still setin a deterministic environment.Goods markets. AUSÞrm z, sells x t (z) units of output in the homemarket and exports v t (z) to the foreign country. Total output of the