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BPEA Article

Toward a Better Understanding of Trade Balance Trends: The Cost-Price Puzzle


THE INADEQUACIES of the time series models of import and export
behavior have long been apparent. To justify the omission of the supply
side, the typical Keynesian function has been based upon the assumptions
of imperfect substitution and infinite supply elasticities of importables
both at home and abroad. While a cyclical variable is sometimes introduced
to capture nonprice rationing effects such as changes in delivery
times (as well as the particular cyclical composition of demand), the most
common specification makes the demand for imports (exports) a function
of their relative price and an activity variable.

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