The law of two prices: trade costs and relative price variability
AbstractThe paper investigates whether deviations from the law of one price can attributed to real factors, such as transportation and distribution costs. Even if trade is costly, the prices of a good at di.erent locations will be linked as long as the good is traded. Instead of the usual iceberg assumption, I model costly trade as a transportation sector that uses real resources with potentially different factor intensities than the production of the good. First I use a latent factor model to see if distance specific ("transportation") and location specific ("retailing") factors can explain deviations from the law of one price across U.S. cities. For many products, these two factors explain 10-20% of all the variation in prices. The estimated transportation factor tends to move together with oil prices. Next I derive the variance of relative prices at di.erent locations when the price of transportation is determined in general equilibrium. This variance is high if (i) the good is costly to transport and (ii) it is produced with different factor intensities than transportation. Preliminary empirical results suggest that goods similar to transportation in terms of factor intensity have indeed lower relative price variability. As these goods tend to be costly to ship, this helps resolve the puzzling finding of Engel and Rogers (2001) that less tradable goods have less volatile relative prices.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences in its series IEHAS Discussion Papers with number 0422.
Length: 32 pages
Date of creation: Dec 2004
Date of revision:
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Alessio Emanuele BIONDO, 2010. "The Law of One Price: Survey of a Failure," Theoretical and Practical Research in Economic Fields, ASERS Publishing, vol. 0(2), pages 168 - 182, December.
- Adrian Wood (QEH), . "Openness is a Matter of Degree: How Trade Costs Reduce Demand Elasticities," QEH Working Papers qehwps169, Queen Elizabeth House, University of Oxford.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Adrienn Foldi).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.