Constant versus Variable Markups: Implications for the Law of One Price
Florida International University
July 15, 2013
We compare the implications of having constant versus variable markups on the Law of One Price. The main innovation, which makes the overall analysis very simple and tractable, is that, when trade implications are estimated to obtain elasticity measures (and thus implied markups), having cases of constant versus (a specific case of) variable markups is reduced to using quantities in logs versus levels on the left hand side of the estimated equations, where the right hand sides are exactly the same; i.e., constant markups correspond to log-linear regressions, while variable markups correspond to lin-log regressions. According to the decomposition of the deviations from the Law of One Price across destination countries, the contribution of trade costs is estimated much higher in the case of variable markups, implying a higher potential for reducing trade costs that would facilitate international trade.
Number of Pages in PDF File: 42
Keywords: Functional Separability, Variable Markups, Trade Costs, Price Elasticity of Demand, Income Elasticity of Demand
JEL Classification: F12, F13, F14working papers series
Date posted: September 10, 2012 ; Last revised: July 23, 2013
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