Markups, Quality and Transport Costs

This paper investigates the impact of transport costs on firm pricing policy. The empiricalpart provides new evidence on trade prices based on firm level data from France. Wefind that for a given product, a typical exporting firm sets higher (net of transport costs)prices toward more distant countries. This empirical regularity suggests that firms chargehigher markups and/or sell more expensive quality up-graded versions of their productwhen facing higher transport costs. None of these two mechanisms is present in models ofinternational trade. Even models with firm heterogeneity in terms of quality fail in explainingthe firm pricing policy observed in the data. We demonstrate that, in existing modelsof trade, for firms to set higher markups or to upgrade the quality of their product towardmore distant countries it is necessary to relax the mill pricing assumption and to use perunit rather than iceberg transport costs. This finding is critical since, in trade models, thestructure of transport costs affects the microeconomic behavior of exporting firms but alsothe composition of export flows and the size of gains from trade.