What Drives Price Differentials of Consumables in Europe?

Prices of many consumables differ substantially across the European Union(EU) due to natural segmentation and to the survival of residual man-made barriers. However, we do not know much about the direction and the cause of deviations among countries diamp;#64256;ering mainly in size and income of their citizens. Here, we wish to fill this gap. We go through some simple theoretical analysis and show that, in the presence of mild barriers to trade, as those persisting among EU countries, prices should be lower in large countries. On the contrary, prices will be higher where people enjoy better standards of living which translate into higher marginal willingness to pay by consumers. We perform a parallel empirical investigation to assess the relative weight of the two main forces driving prices apart across similar countries and we test our theoretical proposition in a simple econometric analysis of prices of consumables across the EU. Country size and affluence explain price differentials in a convincing manner. However, the relative importance of the two variables changes as we consider the EU after the establishment of the Single Market or when we analyse a subsample of fast growing EU members