The Evolution of Price Dispersion in the European Car Market

Car prices in Europe are characterized by large and persistent differences across countries. The purpose of this paper is to document and explain this price dispersion. Using a panel data set extending from 1980 to 1993, two main facts concerning car prices in Europe are demonstrated: (1) the existence of significant differences in quality adjusted prices across countries, with Italy and the United Kingdom systematically representing the most expensive markets; (2) substantial year-to-year volatility that is, to a large extent, accounted for by exchange rate fluctuations and the incomplete response of local currency prices to these fluctuations. These facts are analysed within the framework of a multi-product oligopoly model with product differentiation. The model identifies three potential sources for the international price differences: price elasticities generating differences in mark-ups; costs; and import quota constraints. Based on the results we conjecture that EMU will substantially reduce the year-to-year volatility observed in the car price data, but without further measures to increase European integration, it will not completely eliminate existing cross-country price differences.