Home bias, international price discrimination and economic integration

This paper studies the effects of a further integration of markets that are characterized by intra-industry trade. The analysis is motivated by the observation that product markets of EU countries are more segmented than is usually supposed, which becomes evident e.g. from high differences in prices for identical products. We consider a duopoly model with a home bias in demand that creates an incentive for price discrimination. The effects of reducing trade barriers depend on whether primarily trade costs born by exporting firms decrease or whether arbitrage is enhanced. A fall in arbitrage costs raises the export price, lowers the volume of trade and may result in a reduction of total quantity. Decreasing trade costs reduce prices and expand intra-industry trade; however, the exact effects depend on whether arbitrage constitutes a binding restriction for setting prices. Finally, even measures that equally reduce trade and arbitrage costs may lower the volume of trade.