Imbalances in supply and demand often cause the price for the same goodto vary across geographic locations. Economic theory suggests that ifthe price differential is greater than the cost of transporting the goodbetween locations, then buyers will shift demand from high-pricelocations to lowprice locations, while sellers will shift supply fromlow-price locations to high-price locations. This should make pricesmore uniform and cause the overall market to adhere more closely to the“law of one price.” However, this assumes that traders havethe information necessary to shift their supply/demand in an optimalway. We investigate this using data on over 2 million transactions inthe wholesale used vehicle market from 2003 to 2008. This market hastraditionally consisted of a set of non-integrated regional marketscentered on market facilities located throughout the United States.Supply / demand imbalances and frictions associated with trading acrossdistance created significant geographic price variance for generallyequivalent vehicles. During our sample period, the percentage oftransactions conducted electronically in this market rose fromapproximately 0% to approximately 20%. We argue that the electronicchannel reduces buyers’ information search costs and show thatbuyers are more sensitive to price and less sensitive to distance whenpurchasing via the electronic channel than via the traditional physicalchannel. This causes buyers to be more likely to shift demand away froma nearby facility where prices are high to a more remote facility whereprices are low. We show that these “cross-facility” demandshifts have led to a 25% reduction in geographic price variance duringthe time frame of our sample. We also show that sellers are reacting tothese market shifts by becoming less strategic about vehicledistribution, given that vehicles are increasingly likely to fetch asimilar price regardless of where they are sold.
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