The Law of One Price without the Border: The Role of Distance versus Sticky Prices

We build a single‐country, two‐city, model with nominal rigidities and transport costs which predicts that variation of LOP deviations is lower for goods with infrequent price adjustment after controlling for distance. We adapt the Engel and Rogers (1996) regression to analyse Japanese retail prices at the city level and find that results are consistent with the theoretical predictions. The regression results also suggest that the distance equivalent of nominal rigidities can be as large as the ‘width’ of the border found in the literature on international LOP, casting doubt on casual interpretations of distance as a metric for market segmentation.