Local Costs of Distribution, International Trade Costs and Micro Evidence on the Law of One Price

Using retail price survey data, I investigate whether international goods' market segmentation implied by dispersion in goods' prices is consistent with market segmentation implied by observed trade flows. A Ricardian trade model, with heterogeneous and asymmetric bilateral trade costs, accounts for 85 percent of the average price dispersion and 21 percent of the across good variation in it. Adding good-specific distribution costs reproduces 96.5 percent of the average and 32 percent of the variation in price dispersion. Allowing for good-specific trade costs enables the model to match the average perfectly and explain 48 percent of the variation. While trade and distribution costs explain price dispersion of an average retail good, they account for only half of the across good variation.