Cross-Price Effects and US Trade Elasticities

This article examines the interactions of the import and export markets through cross-prices. The idea is that import demand is affected by export prices, because imports and exports are likely substitutes in consumption. Additionally, import supply is also affected by export prices as exports may be intermediate inputs in the production of imports. The traditional partial equilibrium model of trade is extended to include these cross-price effects in demand and supply. Theoretically, it is shown that these cross-price effects can impede trade balance adjustment in the presence of exchange rate and income shocks. Using quarterly US and rest-of-the-world data from 1975 to 2002, a fully modified general method of moments estimation of the structural equations demonstrates significance of cross-price effects in both the demand and supply of non-petroleum merchandise imports.JEL Classification: F1