As incomes rise, the prices of ________ should rise. Without commensurate increases in ________ the Balassa-Samuelson effect hypothesizes that ________.

Question

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According to the Balassa-Samuelson effect, nontraded goods have a relatively fixed price due to limited competition, while traded goods' prices fluctuate with demand and supply. As incomes rise, demand for nontraded goods increases, causing their prices to rise. This, in turn, causes an increase in wages and productivity in the nontraded sector, leading to an increase in the price of traded goods to maintain the real exchange rate. Therefore, the Balassa-Samuelson effect hypothesizes that as incomes rise, the prices of nontraded goods should rise, and real exchange rates will appreciate without commensurate increases in productivity.

As Incomes Rise, the Prices of ________ Should Rise