February 10, 2009
Pass-Through as an Economic Tool
Posted by D. Daniel Sokol
ABSTRACT: Pass-through rates (at which a monopolist passes on increases in her cost to consumers) play the same role in the comparative statics of monopoly that elasticities do in competitive markets. This makes simple assumptions about them (e.g. that they stay on the same side of 1 over a range of prices) useful for the identification and testing of a wide range of industrial organization models, if data on exogenous cost variations are available. I review the notion of pass-through, establishing a number of new results that show why it is a crucial parameter of monopoly optimization. I then use it to provide a complete (novel) characterization of the relationship between firm and industry mark-ups and profits within and across industrial organization in the classic Cournot (1838)-Spengler (1950) double marginalization problem. I discuss a variety of other applications, some novel to this paper (Cournot competition and the effects of increases in competition on prices) and some from my work elsewhere (two-sided markets) and the work of others (conjectural variations models, mergers in differentiated Bertrand markets and international macroeconomics). I briefly discuss the implications of these results for empirical work, emphasizing the weakness of common functional forms. Finally, I highlight a parametric class of demand functions, first proposed by Bulow and Pfleiderer (1983) based on the stronger assumption of constant pass-through, that has a number of useful properties.
February 10, 2009 | Permalink
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