Pass-Through and Welfare Effects of Regulations that Affect Product Attributes

A key finding in the literature is that the greater the pass-through of an input cost shock or tax to product prices, the larger the welfare loss to consumers. We show that the relationship between pass-through and welfare changes does not hold for a regulation that affects production costs and product attributes. An analytical model shows that the larger the willingness to pay (WTP) for the product attribute, the greater the pass-through but the smaller the welfare loss (or the larger the welfare gain) for consumers. We confi rm this intuition in the context of passenger vehicle fuel economy standards using new estimates of consumer demand and an equilibrium model. Pass-through and welfare changes are positively correlated with WTP for fuel economy across demographic groups and manufacturers. Accounting for WTP breaks the direct link between pass-through and welfare changes identifi ed in prior literature, and in the short run tightening standards is regressive.