Does competition increase pass-through?

Abstract

In recent years, the literature has seen a surge of interest in pass-through as an economic tool. At the same time, widespread concerns have emerged about the rising market power of firms. How does competition affect pass-through? A standard intuition is that more competition makes prices more cost-reflective and hence raises the rate of cost pass- through. This paper shows this conclusion is sensitive to the routine assumption that firms’ marginal costs are constant. With modestly convex costs, market power can raise pass-through (even when it lies below 1). These results have implications for antitrust policy, environmental regulation, and welfare analysis.