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The Balassa-Samuelson relationship: theory, evidence and implications

Zhang, Qi (2011) The Balassa-Samuelson relationship: theory, evidence and implications. PhD thesis, The London School of Economics and Political Science (LSE).

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Abstract

Balassa and Samuelson showed that as we move towards richer countries the measured price level becomes higher. Their proposed explanation was to appeal to the presence of a service element in most goods. In this thesis, I begin by introducing an exploring of an alternative candidate explanation for the B-S relationship. This explanation is based on an appeal to mismeasured quality. In the model developed in Chapter 2, the well-known difficulties surrounding the problem of making a full and appropriate adjustment for differing quality levels will mean that when the average quality level consumed is higher in richer countries, this will showup in the data as spurious difference in price levels, which will imply the B-S relationship. More interestingly, it also leads to a second testable prediction that is not a prediction of the classic B-S explanation. This second prediction is tested directly at the end of Chapter 2. In testing this prediction, we are led naturally to explore the foundation of the B-S relationship at a disaggregate level. In Chapter 3, we take a purely statistical approach in asking the question: what is the best statistical description of wealth versus price level relationship for individual products? We arrive at a characterization of the best statistical description which suggests a natural way of ordering products relative to the form of this relationship. A striking pattern emerges, according to which products at the one end of the spectrum are almost all manufactured goods (designated the ‘M-group’), while products at the other end of the spectrum are almost all pure services (designated the ‘S-group’). In Chapter 4 and 5, we return to theory. We propose a separate model for the S-group in Chapter 4. In Chapter 5 we return to the analysis of Chapter 2, but now we apply the analysis to the M-group only. Chapter 6 is devoted to exploring the macroeconomic implications of the B-S relationship. The key idea is that a (fast) growing economy will exhibit a (substantial) temporary episode of inflation, as measured by conventional price indices.

Item Type: Thesis (PhD)
Additional Information: © 2011 Qi Zhang
Library of Congress subject classification: H Social Sciences > HB Economic Theory
Sets: Departments > Economics
Supervisor: Sutton, John
URI: http://etheses.lse.ac.uk/id/eprint/642

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