The Price of Distance: Pricing to market, producer heterogeneity, and geographic barriers

Transport costs are generally attributable to price differentials across geographically separated regions. However, when using price differential data, the identification of distance-elastic transport costs depends on how producers handle transport costs and set prices in remote markets. To address this problem, we adopt a nonhomothetic preference framework with heterogeneous producers. We show that the presence of nonhomothetic preferences is important in causing producer heterogeneity to alter individual pricing behavior depending on market conditions, a property absent in the constant elasticity of substitution heterogeneity framework. This also exhibits the property that producers do not fully pass on the increase in transport costs. By not accounting for these features, the distance elasticity of transport costs is underestimated. However, by incorporating these features in our model and using empirical analysis and microlevel data, we reveal that the distance effect is significantly large, suggesting that the price of geographic barriers for regional transportation is high.