Inter-sectoral relative price, inflation and structural transformation

Abstract

While the pattern of composition of sectoral output and consumption are well stylised during growth and structural transformation of an economy, the evidence on the movement of inter-sectoral relative price is mixed across countries. This paper investigates how demand and supply side forces simultaneously shape structural transformation and the path of relative price in a two-sector economy comprising an agricultural and a non-agricultural sector. The model incorporates non-homothetic preference, heterogeneous sectoral production functions with heterogeneous and exogenous total factor productivity growth. We further investigate how the equilibrium path of relative price contributes to inflation measured by proportionate changes in the aggregate price level which is an index of sectoral prices. We find that the equilibrium rate of inflation is always positive during structural transformation. The rate of inflation increases with increase in growth rate of the non-agricultural sector and with a higher preference for agricultural goods, and reduces with an increase in the growth of the agricultural sector.