International macroe.. - Free

9.2. PRICING TO MARKET 287US Þrm is y t (z) =x t (z)+v t (z). The per-unit dollar price of US salesis set at p t (z) and the per-unit euro price of exports is set at q ∗ t (z).AEuropeanÞrm z ∗ sells x ∗ t (z ∗ ) units of output in Europe at thepre-set euro price p ∗ t (z ∗ ) and exports v ∗ t (z ∗ )totheUSwhichitsellsatapre-setdollar price of q t (z ∗ ). Total output of the European Þrm isy ∗ t (z∗ )=x ∗ t (z∗ )+v ∗ t (z∗ ).Home Countryy=x+vx sells at home at dollarprice pForeign Countryv* sells at home atdollar price q0 nv sells abroad ateuro price q*y*=x*+v*x* sells in foreign countryat euro price p*1Figure 9.2: Pricing-to-market home and foreign households lined up onthe unit interval.Asset Markets. The internationally traded asset is a one-period nominalbond denominated in dollars. Restricting asset availability placespotential limits on the degree of international risk sharing that can beachieved. Since violations of the law of one price can now occur, so canviolations of purchasing power parity. It follows that that real interestrates can diverge across countries. Since intertemporal optimalityrequires that agents set the growth of marginal utility (consumptionin the log utility case) to be proportional to the real interest rate, theinternational inequality of real interest rates implies that home andforeign consumption will be not be perfectly correlated.The bond is sold at discount and has a face value of one dollar.Let B t be the dollar value of bonds held by domestic households, andBt ∗ be the dollar value of bonds held by foreign households. Bondsoutstanding are in zero net supply nB t +(1− n)Bt∗ = 0. The dollar