According to the Balassa-Samue

According to the Balassa-Samuelson effect, price levels arerelated to productivity in the tradables sector.

a. Explain the intuition behind the Balassa-Samuelsoneffect.

b. What does the Balassa-Samuelson effect imply for differencesin price levels between rich and poor countries?

c. What does the Balassa-Samuelson effect imply for differencesin inflation between rich and poor countries?


a. Balassa-Samuelson effect states that highgrowth in production of goods lead to high wage rate, which in turnincreases the purchasing power of the consumer. This further leadsto price inflation and hence increase in inflation rate.Surprisingly, developing countries show more inflation rate ascompared to developed countries as developing countries are moretend to become more productive and hence leads to increase in wagerate and inflation rate.

b. Poo countries are in the categories ofdeveloping countries and these countries are more focused towardsproduction that leads to growth in production rate.Increasedproduction leads to increase wage rate and further leads toincrease in price.On the other hand, rich countries are in thecategories of developed countries and their relative growth is notmuch and hence it does not further leads to price inflation as incase of developing countries.

c. From point B, it is clear that as perBalassa-Samuelson effect, poor countries are more prone to highwage rate as compared to rich and developed countries.High pricerate in poor countries, lead to high inflation rate in comparisonto rich and developed countries.

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