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Market Structure and Exchange Rate Pass-Through

  • Raphael S. Schoenle

    ()

    (Economics Department, Brandeis University)

  • Raphael A. Auer

    ()

    (Swiss National Bank)

In this paper, we first document that two predictions of the heterogeneous firm version of the Dornbusch (1987) pricing model are confirmed in micro data on US import prices: while the rate at which a firm reacts to changes in its own cost is U-shaped in market share, the rate at which it reacts to competitors’ prices is hump-shaped in market share. Second, using the theory as a guidance, we present an expression for price changes in industry equilibrium that can be broken down into a component due to the direct cost response at the firm level, and another one due to price complementarities faced by the firm at the industry level. We show empirically that taking into account a sector’s market structure and the interplay of heterogeneity in reaction to own cost and reaction to the competition can substantially improve our understanding of the variation in pass-through rates across sectors and trade partners. The direct imperfect cost pass-through channel and the indirect price complementarity channel play approximately equally important roles in determining pass-through but partly offset each other. Including only one of these channels in an empirical analysis results in a failure to explain variation in the aggregate equilibrium rate of pass-through.

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File URL: http://www.brandeis.edu/departments/economics/RePEc/brd/doc/Brandeis_WP62.pdf
File Function: First version, 2013
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Paper provided by Brandeis University, Department of Economics and International Businesss School in its series Working Papers with number 62.

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Length: 39 pages
Date of creation: Sep 2013
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Handle: RePEc:brd:wpaper:62
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