Accounting for the ¡°Subnational Penn Effect¡±¡ªA General Theory of Regional and National Price Levels

As an extension of the neoclassical urban systems theory (Henderson, 1974), we develop a general theory of regional (inter-city) price dispersion which also explains the ¡°subnational Penn effect,¡± i.e., cross-city correlations among population size, prices, real income and human capital stock. The model is also a theory of international price dispersion that is observationally equivalent to and more appealing than the Balassa-Samuelson theory, implying that the (international) Penn effect may simply be an aggregate result of the ¡°subnational Penn effect.¡± Furthermore, it shows that, contrary to the popular view, economic integration can increase as well as decrease spatial price variation.