DP2029 | The Evolution of Price Dispersion in the European Car Market

Publication Date

18/12/1998

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Abstract

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.