Abstract Empirical studies find that the pass-through of input cost changes to prices is incomplete: a 10 percent increase in costs causes downstream prices to rise less than 10 percent, even at long horizons. Using microdata from gas stations, food products, and manufacturing industries, we find that incomplete pass-through in percentages often disguises complete pass-through in levels: a 1/unit increase in input costs leads to 1/unit higher downstream prices. Pass-through appears incomplete in percentages due to a gap between prices and costs. Complete pass-through in levels contrasts with workhorse macroeconomic models that feature homothetic demand systems. We identify an alternative class of demand systems that yields pass-through in levels and highlight four implications. First, measuring pass-through in percentages can lead to spurious evidence of asymmetry and size-dependence. Second, pass-through in levels leads to systematic fluctuations in relative price and markup dispersion that are not associated with changes in allocative efficiency. Third, pass-through in levels can explain dynamics of industry gross margins, operating profits, and entry in the data that are at odds with workhorse models. Finally, incorporating pass-through in levels into an input-output model of the U. S. economy better matches the volatility of consumer price inflation and the response of inflation to identified shocks.
Kunal Sangani (Wed,) studied this question.