Constant versus Variable Markups: Implications for the Law of One Price
Florida International University
April 12, 2016
This paper compares 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 a trade model, it is shown that the case of constant markups corresponds to log-linear trade regressions, while the case of variable markups corresponds to lin-log trade regressions. Empirical results show that marginal costs of production contribute most to the deviations from LOP for both cases of constant and variable markups; the decomposition of marginal costs further shows that destination-specific quality measures play the biggest role.
Number of Pages in PDF File: 34
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: April 12, 2016