Demand Complementarities and Cross-Country Price Differences

This paper presents a two-country model in which consumers’ utility from tradable goods depends on their consumption of complementary goods and services. The model is consistent with the stylized fact that markups are higher in rich countries: In countries with more complementary goods and services consumer demand is less elastic, enabling monopolistically competitive firms to charge higher prices. The paper provides empirical evidence supporting the notion that demand complementarities leads to high prices in rich countries, conditional on the dependence of prices on alternative mechanisms associated with pricing-to-market. The paper explores additional implications for prices of nontradable services and aggregate price indices. JEL:E31, F12, L11