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212 CHAPTER 7. THE REAL EXCHANGE RATEα, this is equivalent to an additional 75,000 miles of distance betweentwo cities in the same country. In addition, the border was found toaccount for 32.4 percent of the variation in the σ ijk , while log distancewas found to explain 20.3 percent.The striking differences between within country violations of thelaw-of-one price and across country violations raise but do not answerthe question, “Why is the border is so important?” This is still an openquestion but possible explanations include,1. Barriers to international trade, such as tariffs, quotas, and nontariffbarriers such as bureaucratic red tape imposed on foreignbusinesses. The Engel-Rogers sample spans periods of pre- andpost-trade liberalization between the US and Canada. In subsampleanalysis, they reject the trade barrier hypothesis.2. Labor markets are more integrated and homogeneous within countriesthan they are across countries. This might explain why therewould be less volatility in per unit costs of production across citieswithin the same country and more per unit cost volatility acrosscountries.3. Nominal price stickiness. Goods prices seem to respond to macroeconomicshocks and news with a lag and behave more sluggishlythan asset prices and nominal exchange rates. Engel and RogersÞnd that this hypothesis does not explain all of the relative pricevolatility. 34. Pricing to market. This is a term used to describe how Þrmswith monopoly power engage in price discrimination between segmenteddomestic and foreign markets characterized by differentelasticities of demand.3 The experiment they run here is as follows. Instead of measuring the relativeintercity price as p ijt /(S t p ∗ ikt )whereS is the nominal exchange rate, p is the USdollar price and p ∗ is the Canadian dollar price, replace it with (p ijt /P t )/(Pt ∗/p∗ ikt )where P and P ∗ are the overall price levels in the US and Canada respectively. If theborder effect is entirely due to sticky prices, the border should be insigniÞcant whenthe alternative price measure is used. But in fact, the border remains signiÞcant sosticky nominal prices can provide only a partial explanation.