Equilibrium Price Dispersion and the Border Effect

Abstract

We find that observed cross-country price differences primarily reflect regional market segmentation occurring within countries. Using a model of price-setting subject to costly search, we show that identification of national versus regional segmentation requires augmenting price data with regional trade flow data. Calibrating the model to data from U.S. and Canadian regions, we estimate substantial regional trade frictions: U.S. producers are three times less likely to sell to retailers in the away region of the United States than in their own region, and only slightly less likely to sell to a region in Canada, controlling for market size differences. Canadian producers have an even stronger home bias: they are 7 times more likely to sell in their own region than in the away region in Canada, and 11 times more likely to sell in their own region than in a U.S. region. Models that do not explicitly account for regional home bias can misstate the severity of segmentation at the national border.