Consumer Search, Price Dispersion, and International Relative Price Volatility

Consumer search frictions permit firms to price discriminate across markets based on the local wage of consumers. With price dispersion, the market price of a good does not measure its resource cost. This breaks the tight link between relative quantities and relative prices implied by most models. The author shows that volatile and persistent fluctuations in relative wages lead to volatile and persistent fluctuations in relative prices at the disaggregate level. These deviations from the law of one price substantially increase international relative price volatility. With productivity and taste shocks, the model generates international business cycles that closely match the data.