Cost pass-through elasticities, concentration and productivity growth

Abstract

Cost pass-through elasticities measure the percentage decrease in prices from a percentage cost reduction. For given cost reductions, lower elasticities harm consumers through a lower pass-through to prices. But these same lower elasticities may increase cost-reducing innovation by firms and thereby help consumers by leading to lower prices. To explore this trade-off, pass-through elasticities are first estimated for 253 US manufacturing industries. After this, two second-stage regressions that use the estimated elasticities are introduced. The first regression finds that higher seller concentration leads to lower pass-through elasticities, whereas the second finds that the lower pass-through elasticities, which accompany higher concentration, lead to higher average annual productivity growth. This means there is a trade-off, and lower elasticities can benefit consumers.

Notes

¹The approach taken in estimating the price equations broadly follows that of Yang (1997), who estimates exchange-rate pass-through elasticities for 87 US industries. For a comprehensive review of the empirical pass-through literature, see Stennek and Verboven (2001). Most of this literature looks at the pass-through for a specific industry although the literature dealing with the pass-through from exchange rates to import prices often looks at a sample of industries.

²The intuition for this result is straightforward for markets with linear demand and constant costs. Here a unit reduction in costs reduces prices by the same amount in competition, but only by half that amount in monopoly. The smaller response in monopoly occurs because the monopolist determines output using the marginal revenue curve that has twice the slope of the market demand curve. This result and other results for equilibrium positions between competition and monopoly are developed in Stennek and Verboven (2001).

³The price regulation literature has been interested in the potential benefits from gaps between cost and price changes. For example, the argument for price-cap regulation, which decouples cost and price, in place of cost-of-service regulation is that the decoupling encourages efficiency and innovation. Majumdar (1997) presents empirical evidence that price-cap regulation improves the efficiency of US local exchange carriers.