Costly price adjustment and export pricing behavior for U.S. and Japanese manufacturing firms
The law of one price states that the same good selling in two different countries should sell for the same price when expressed in a common currency. However, numerous empirical studies suggest that price differentials are too large to be explained solely by transportation costs or trade taxes, and they also persist for long periods of time. There seems to be a destination-specific markup adjustment by exporters, which are driven by exchange rate movements. To help explain this pricing-to-market behavior, a monopolistic pricing model is developed and tested. The monopolist is assumed to face price adjustment costs in the domestic and export markets. Maximization of the discounted sum of expected profits leads to a forward-looking quadratic adjustment cost model. Explicit solutions to the pricing equations are derived by using the stochastic properties of the nominal effective exchange rate. Given the domestic and export pricing equations, the extent of deviations from the law of one price is studied by specifying an empirical equation (in the form of a quasi-error correction model) concerning the industry real exchange rate. Using domestic and export price indices for 11 industries in the United States and Japan, regression results suggest a marked difference in the pricing behavior of U.S. and Japanese manufacturers. All U.S. manufacturing industries in the study face a significantly higher price adjustment cost in the foreign market than in the domestic market, but only 3 Japanese industries do so. This leads to greater deviations from the law of one price for U.S. firms, compared to their Japanese counterparts. The model also allows a peek at another interesting empirical question, namely, the difference in domestic vs. foreign elasticities of demand for some industries.
Araneta, Ricardo Valera, "Costly price adjustment and export pricing behavior for U.S. and Japanese manufacturing firms" (1994). ETD Collection for Fordham University. AAI9425184.