The Penn Effect within a Country - Evidence from Japan

To control for product quality and exchange rate effects, we use the Japanese regional data to study the Penn effect – the positive relationship between price and income levels. Comparable with the evidence from international data, the Penn effect is significant in the Japanese prefectural data and driven mainly by the prices of nontradables. We draw upon studies of productivity and economic density to explain the positive price-income relationship, and find that the empirical economic density variables explain the variability of the Japanese prefectural (relative) prices quite well.