Introduction

Large differences in car prices across countries have been a persistent phenomenon in Europe. A series of studies by the European Bureau of Consumers Unions, BEUC (1981, 1986, 1989, 1992), shows that pretax prices for identical car models may vary by over 90 per cent across countries. Mertens and Ginsburgh (1985) construct a quality-adjusted price index for the whole industry and find that the general pretax price level in Belgium, France, Germany, Italy, and the United Kingdom varies by up to 30 per cent. Although the price differences have somewhat diminished during the past decade (Ginsburgh and Vanhamme, 1989; Mertens, 1990), they remain quite large, and they are not likely to disappear in the near future. Flam (1992) reports that current pretax price differences of 90 per cent for identical car models are still no exception. The question arises why profit-maximizing firms find such large price differences desirable. Do car producers face different costs of operating in the various markets? Or, alternatively, do firms charge different markups in different countries and engage in international price discrimination?

To address these questions, I construct and estimate an oligopoly model that captures the essential determinants of pricing behaviour in the European car market.