The Evolution of Price Dispersion in the European Car Market¤

Car prices in Europe are characterized by large and persistent di®erences 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, we ̄rst demonstrate two main facts concerning car prices in Europe: (1) The existence of signi ̄cant di®erences in quality adjusted prices across countries, with Italy and the U.K. systematically representing the most expensive markets. (2) Substantial year-to-year volatility that is to a large extent accounted for by exchange rate °uctuations and the incomplete response of local currency prices to these °uctuations. These facts are analyzed within the framework of a multiproduct oligopoly model with product di®erentiation. The model identi ̄es three potential sources for the international price di®erences: price elasticities generating di®erences in markups, costs, and import quota constraints. Local currency price stability can be attributed either to the presence of a local component in marginal costs, or to markup adjustment that is correlated with exchange rate volatility; the latter requires that the perceived elasticity of demand is increasing in price. We ̄nd that the primary reason for the higher prices in Italy is the existence of a strong bias for domestic brands that generates high markups for the domestic ̄rm (Fiat). In the U.K. higher prices are mainly attributed to better equipped cars and/or di®erences in the dealer discount practices. The import quota constraints are found to have a signi ̄cant impact on Japanese car prices in Italy, France and the U.K.. With respect to local currency price stability, a large percentage of the documented price inertia can be attributed to local costs, and a smaller fraction to markup adjustment that is indicative of price discrimination. Based on these results we conjecture that the 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 di®erences. ¤We gratefully acknowledge funding from a National Science Foundation Grant to the NBER (Grant SBR9731979), an Alfred P. Sloan Foundation Research Fellowship to Goldberg, and a grant by the Belgian Science Foundation (Fonds Wetenschappelijk Onderzoek, 774810/8/F01/6260/131200) to Verboven. We also thank the Center for Economic Research (Tilburg University) for providing ̄nancial and organizational support in collecting the data. This version has bene ̄ted substantially from the comments of the editor and the anonymous referees. We are of course responsible for any remaining errors.