An Analysis of International Price Differentials on eBay

By Maier, Philipp | Contemporary Economic Policy, July 2010 | Go to article overview

An Analysis of International Price Differentials on eBay


Maier, Philipp, Contemporary Economic Policy


I. INTRODUCTION

No one likes to pay too much. In the language of economists, this translates into the "law of one price," which essentially says that if different prices are charged for similar goods at different locations, some clever agent will engage in arbitrage. By buying goods at cheap locations and selling them where prices are high, he forces prices to converge. Despite the intuitive appeal of the law of one price, empirical evidence is mixed. Prices are found to differ within cities, between cities, and between countries. (1) Of particular interest for this study is that empirical analysis has found evidence of "border effects," that is, prices between countries differ by more than prices within a country. (2) The border effect is typically explained by lack of transparency, that is, exchange rates hampering trade, as they require tedious conversion of foreign prices into home currency (Parsley and Wei, 1996). Are there "borders" on the Internet?

The Internet has changed the way consumers and sellers interact. The introduction of modern communication technologies has increased price transparency: online shops in foreign countries can be browsed free of charge, Internet Web sites aid consumers to find the cheapest prices, and ample opportunities exist for comparing prices across countries. Moreover, payment sites as PayPal.com facilitate cross-border purchases. Online markets are a step closer to an economist's ideal of a frictionless, competitive market. A related effect of the Internet is that it offers new ways to measure prices. Online auctions provide economists with data that can be used to measure prices and investigate price formation.

Using data from eBay, we investigate price differentials in Europe. Of all Internet auction sites, eBay is the largest one, and its (economic) importance is rapidly growing: According to its annual report, 180.6 million users from more than 150 countries listed 1.9 billion items on eBay in 2005. The total value of goods sold that year reached nearly 44 billion U.S. dollars, representing a 30% increase over 2004. Compared with, for example, scanner data from supermarkets, Internet auctions have a number of advantages: first, prices for a broad range of goods are easily observable. Second, all items are shipped by surface mail and thus highly tradable. Third, goods do not require costly display in shops. This reduces the non-tradable cost component, relative to "traditional" retailers. And lastly, comparing online auction prices is simply more realistic than investigating international price differentials in supermarkets: few, say, Italian consumers would drive to the United Kingdom to do grocery shopping, but it is not unreasonable to assume that they buy an English copy of a Harry Potter book at eBay from a British seller.

We examine two issues: First, comparing prices consumers pay for tradable goods in different countries, we establish that online consumers pay different prices for similar goods. Second, we want to get insights into the causes of these price differentials. Does the "border effect" stem from countries, having different currencies, or from having national borders? We do this by comparing prices between the United Kingdom and the euro area and within the euro area. Price differentials within the euro area cannot stem from different currencies, as all countries share the euro as common currency. To preview the conclusions, we find evidence of substantial differences in price levels. In addition, price dispersion seems to be related to whether or not countries share a common currency. Hence, we find evidence that national borders create frictions (which result in price differentials), and the magnitude of the differential is increasing if countries do not share a common currency.

This study contributes to the literature in several ways. First, we use eBay to evaluate a macroeconomic concept. Second, this is one of the first studies to use data from the euro area and the United Kingdom to analyze the source of the "border effect. …

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