We propose a simple spatial model to explain why the price level is higher in rich countries. There are two sectors: manufacturing, which is freely tradable, and non-tradable services, which have to locate near customers in big cities. As countries develop, total factor productivity increases...

evidence on the asymmetry of inflation response to aggregate shocks. We show that even though a standard menu cost model like that of Golosov and Lucas (2007) underestimates the asymmetry, a sectoral menu cost model with multi-product firms and trend-inflation can quantitatively account for the...