Analyzing Changes in Market Integration through a Cross-Sectional Test for the Law of One Price

This paper presents a theoretical argument that the relationship between price differences and per capita demand differences across locations can be used as a cross-sectional test for the law of one price. Since the relationship should be statistically insignificant or very weak in an integrated economy, its strength can measure the extent of market integration. A sequence of crosssectional estimations for a number of points in time provides the temporal pattern of integration, so enabling changes in integration to be traced. Besides that, the basic equation may be augmented by additional variables representing potential culprits behind market segmentation so as to estimate their impeding impact to integration. This methodology is empirically verified in the paper by applying it to the Russian internal market. The data used span 1992–1999, and cover most regions of Russia; the cost of a uniform basket of basic food goods and spatial price indices are implemented as price indicators. A number of culprits behind market segmentation are identified, organized crime among them.