Constant versus Variable Markups: Implications for the Law of One Price
Florida International University
January 20, 2014
We compare the implications of having constant versus variable markups on the Law of One Price (LOP) by decomposing the good-category level prices into marginal costs of production, markups, and trade costs. Using trade data on both quantities and prices, together with a demand-side model, constant markups are estimated using log-linear trade regressions, while variable markups are estimated using lin-log trade regressions. Estimated markups are further used to decompose prices into their components, after controlling for quality and time-to-trade. The results show that trade costs contribute most to the deviations from LOP, especially in the case of variable markups.
Number of Pages in PDF File: 35
Keywords: Functional Separability, Variable Markups, Trade Costs, Price Elasticity of Demand, Income Elasticity of Demand
JEL Classification: F12, F13, F14
Date posted: September 10, 2012 ; Last revised: January 21, 2014
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