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Local Costs of Distribution, International Trade Costs and Micro Evidence on the Law of One Price

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  • Giri, Rahul

Abstract

Observed trade flows provide one metric to gauge the degree of international goods market segmentation. Deviations from the law of one price provide another. New survey data on retail prices for a broad cross section of goods across 13 EU countries, compiled by Crucini, Telmer and Zachariadis (2005), show that (i) the average dispersion of law of one price deviations across all goods is 28 percent and (ii) the range of that dispersion across goods is large, varying from 2 percent to 83 percent. Quantitative multi-country Ricardian models, a la Eaton and Kortum, use data on bilateral trade volumes to estimate international trade barriers or trade costs. This paper investigates whether the degree of international goods market segmentation implied by these models can account for observed cross-country dispersion in prices. When heterogeneous and asymmetric trade costs are carefully calibrated to match observed bilateral trade volumes, the model can account for 85 percent of the average dispersion of law of one price deviations found in the data. However, it generates only 21 percent of the good by good variation in price dispersion. The model is augmented to permit heterogeneity in local costs of distribution - across goods and countries - and is calibrated to match data on distribution margins. While the augmented model can reproduce 96.5 percent of the average dispersion of law of one price deviations, it can match only 32 percent of the variation in that dispersion. Heterogeneity in trade costs, and in local distribution costs, cannot account for observed heterogeneity in the dispersion of law of one price deviations.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 11006.

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Date of creation: 12 Aug 2008
Date of revision: 31 Sep 2008
Handle: RePEc:pra:mprapa:11006

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Keywords: Trade; international trade costs; distribution costs; law of one price; price dispersion;

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Cited by:
  1. Mario J. Crucini & Christopher I. Telmer, 2012. "Microeconomic Sources of Real Exchange Rate Variability," NBER Working Papers 17978, National Bureau of Economic Research, Inc.
  2. Betts, Caroline & Giri, Rahul & Verma, Rubina, 2013. "Trade, Reform, And Structural Transformation in South Korea," MPRA Paper 49540, University Library of Munich, Germany.
  3. Jörgensen, Christian & Persson, Morten, 2013. "The Market for Tractors in the EU: Price Differences and Convergence," Factor Markets Working Papers, Centre for European Policy Studies 145, Centre for European Policy Studies.
  4. Michael Sposi, 2013. "Trade barriers and the relative price tradables," Globalization and Monetary Policy Institute Working Paper, Federal Reserve Bank of Dallas 139, Federal Reserve Bank of Dallas.
  5. Jorgensen, Christian & Persson, Morten, 2013. "The Market for Tractors in the EU: Price Differences and Convergence," Working Papers, Factor Markets, Centre for European Policy Studies 144005, Factor Markets, Centre for European Policy Studies.

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