THE EFFECT OF TRADE CREDIT ON PRICE AND PRICE LEVEL COMPARISONS.

This paper describes a model linking transactions prices and trade credit. It demonstrates that prices of identical goods will differ, even in perfectly efficient markets for goods and capital, if credit terms differ. As a result, apparent arbitrage profits may disappear when prices are adjusted for the value of trade credit extended to finance goods. One major component is the length of time for which trade credit is extended. Within a single economy different explicit or implied credit maturities translate into different credit costs. In turn, these costs are reflected in price differences. A good example is the recent use of merchant discounts for cash payments as a disincentive against credit card payment. The amount of the discount is directly related to merchants' cost of funds. When prices are compared internationally, another element is added. Variations in the cost of credit extended in different currencies may reflect differences in interest rates and expected inflation. When compared at the current exchange rate the national prices of goods sold on credit should differ by the variation in the cost of providing that credit. The reflection of trade credit in the relationship between prices, exchange rates and interest rates has several interesting implications.