Price convergence among Indian cities: The role of linguistic differences, topography, and aggregation

Abstract This study examines the validity of the Law of One Price (LOP) by using monthly retail price data for 24 commodities across 78 locations for the period January 2007–December 2017 in the linguistically and topographically diverse India. We focus on the influence of communication costs and transportation costs on market integration and price convergence. Using panel unit root tests, we find that lower communication costs, due to commonly spoken languages, and lower transportation costs, resulting either from shorter geographic distances or from lower variations in topographical features across locations, yield faster rates of price convergence. Furthermore, the level of aggregation of data is crucial in testing the LOP. “Aggregation bias” refers to empirical findings of goods-level data yielding faster convergence than aggregate price indices. We observe signs of aggregation bias in price convergence in India.