Price Dispersion across U.S. Districts of Entry
One sentence summary: Markups explain about 31% of the price dispersion across U.S. districts of entry, while marginal costs of production explain about 69%.
The corresponding paper by Hakan Yilmazkuday has been published at Economics Letters.
Abstract
Price dispersion of U.S. imports are investigated across U.S. districts of entry. Markups explain about 31% of price dispersion, while marginal costs of production explain about 69%; effects of trade costs, for which we have actual data, are almost none.
Non-technical Summary
In international economics, typical components of prices are marginal costs of production (excluding trade costs), markups, and trade costs. Therefore, decomposing prices into their components is the key in understanding the price dispersion across locations and thus the deviations from the Law of One Price (LOP). However, this is not an easy task, since data for such components are mostly not available; this has led researchers rather focus on the implications of economic models for estimating these components.
Using actual data on trade costs (i.e., cost, insurance, freight, and duties/tariffs), together with a simple model based on variable markups, this paper shows that marginal costs of production and markups are the main sources of variation in prices; the effects of trade costs are almost none. In particular, marginal costs of production explain about 69% and markups about 31% of the price dispersion of U.S. imports across U.S. districts of entry (i.e., the district in which merchandise clears customs) on average.
The results are robust to the consideration of possible endogeneity problems, multiplicative versus additive trade costs (due to having actual data on trade costs), and measurement errors in prices. Therefore, studies that proxy the actual data on trade costs by distance/border effects may well be capturing any unmodeled part of preferences in utility functions, such as dyadic demand shifters, rather than actual trade costs. If preferences are the main source of trade barriers, policies aimed to increase welfare-improving trade would require more than just reducing duties/tariffs.