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Incomplete Cost Pass-Through Under Deep Habits

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  • Ravn, Morten O
  • Schmitt-Grohé, Stephanie
  • Uribe, Martín

Abstract

A number of empirical studies document that marginal cost shocks are not fully passed through to prices at the firm level and that prices are substantially less volatile than costs. We show that in the relative-deep-habits model of Ravn, Schmitt-Grohé, and Uribe (2006), firm-specific marginal cost shocks are not fully passed through to product prices. That is, in response to a firm-specific increase in marginal costs, prices rise, but by less than marginal costs leading to a decline in the firm-specific markup of prices over marginal costs. Pass-through is predicted to be even lower when shocks to marginal costs are anticipated by firms. In our model unanticipated firm-specific cost shocks lead to incomplete pass-through (or a decline in markups) of about 20 percent and anticipated cost shocks are associated with incomplete pass-through of about 50 percent. The model predicts that cost pass-through is increasing in the persistence of marginal cost shocks and U-shaped in the strength of habits. The relative-deep-habits model implies that conditional on marginal cost disturbances, prices are less volatile than marginal costs.

Suggested Citation

  • Ravn, Morten O & Schmitt-Grohé, Stephanie & Uribe, Martín, 2008. "Incomplete Cost Pass-Through Under Deep Habits," CEPR Discussion Papers 6674, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:6674
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    Citations

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    Cited by:

    1. Di Pace, F. & Faccini, R., 2012. "Deep habits and the cyclical behaviour of equilibrium unemployment and vacancies," Journal of Economic Dynamics and Control, Elsevier, vol. 36(2), pages 183-200.
    2. Hellerstein, Rebecca & Villas-Boas, Sofia B., 2010. "Outsourcing and pass-through," Journal of International Economics, Elsevier, vol. 81(2), pages 170-183, July.
    3. Pinelopi Koujianou Goldberg & Rebecca Hellerstein, 2006. "A Framework for Identifying the Sources of Local-Currency Price Stability with an Empirical Application," 2006 Meeting Papers 625, Society for Economic Dynamics.
    4. Kleshchelski, Isaac & Vincent, Nicolas, 2009. "Market share and price rigidity," Journal of Monetary Economics, Elsevier, vol. 56(3), pages 344-352, April.
    5. Shirota, Toyoichiro, 2017. "Not All Exchange Rate Movements Are Alike : Exchange Rate Persistence and Pass-Through to Consumer Prices," Discussion paper series. A 311, Graduate School of Economics and Business Administration, Hokkaido University.
    6. Davis, J. Scott & Huang, Kevin X.D., 2011. "International real business cycles with endogenous markup variability," Journal of International Economics, Elsevier, vol. 85(2), pages 302-316.
    7. Vardges Hovhannisyan, 2018. "A structural model of cost pass-through: the case of the US yogurt retailing," Empirical Economics, Springer, vol. 55(2), pages 805-830, September.
    8. Abbritti, Mirko & Aguilera-Bravo, Asier & Trani, Tommaso, 2021. "Long-term business relationships, bargaining and monetary policy," Economic Modelling, Elsevier, vol. 101(C).
    9. Reto Foellmi & Christian Hepenstrick & Josef Zweimüller, 2010. "Non-homothetic preferences, parallel imports and the extensive margin of international trade," Diskussionsschriften dp1009, Universitaet Bern, Departement Volkswirtschaft.
    10. Jacob, Punnoose & Uusküla, Lenno, 2019. "Deep habits and exchange rate pass-through," Journal of Economic Dynamics and Control, Elsevier, vol. 105(C), pages 67-89.
    11. Nikolay Hristov, 2016. "The Ifo DSGE Model for the German Economy," ifo Working Paper Series 210, ifo Institute - Leibniz Institute for Economic Research at the University of Munich.
    12. Pinelopi Koujianou Goldberg & Rebecca Hellerstein, 2006. "A Framework for Identifying the Sources of Local-Currency Price Stability with an Empirical Application," 2006 Meeting Papers 625, Society for Economic Dynamics.
    13. Mirko Abbritti, 2012. "Product Market Frictions, Bargaining and Pass-Through," Faculty Working Papers 19/12, School of Economics and Business Administration, University of Navarra.
    14. Mirko Abbritti & Tommaso Trani, 2014. "Search and Bargaining in the Product Market and Price Rigidities," Faculty Working Papers 09/14, School of Economics and Business Administration, University of Navarra.
    15. Antoniou, Fabio & Fiocco, Raffaele, 2020. "Storable good market with intertemporal cost variations," MPRA Paper 97948, University Library of Munich, Germany.
    16. repec:pri:cepsud:185goldberg is not listed on IDEAS
    17. Anna Laura Baraldi & Christian Rojas, 2011. "Cost Pass-Through with Network Externalities," International Journal of Business and Economics, School of Management Development, Feng Chia University, Taichung, Taiwan, vol. 10(3), pages 177-199, December.
    18. Adachi, Takanori & Ebina, Takeshi, 2014. "Double marginalization and cost pass-through: Weyl–Fabinger and Cowan meet Spengler and Bresnahan–Reiss," Economics Letters, Elsevier, vol. 122(2), pages 170-175.

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    More about this item

    Keywords

    cost pass-through; deep habits; markups;
    All these keywords.

    JEL classification:

    • D1 - Microeconomics - - Household Behavior
    • D4 - Microeconomics - - Market Structure, Pricing, and Design
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance

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