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Discussion Paper Details

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Title: Quality Pricing-to-Market

Author(s): Raphael Auer, Thomas Chaney and Philip Saur�

Publication Date: July 2014

Keyword(s): exchange rate pass-through, intra-industry trade, monopolistic competition, pricing-to-market and vertical differentiation

Programme Area(s): Industrial Organization, International Macroeconomics and International Trade and Regional Economics

Abstract: We examine firm's pricing-to-market decisions in vertically differentiated industries featuring a large number of firms that compete monopolistically in the quality space. Firms sell goods of heterogeneous quality to consumers with non-homothetic preferences that differ in their income and thus their marginal willingness to pay for quality increments. We derive closed-form solutions for the pricing game under costly international trade, thus establishing existence and uniqueness. We then examine how the interaction of good quality and market demand for quality affects firms' pricing-to-market decisions. The relative price of high quality goods compared to that of low quality goods is an increasing function of the income in the destination market. When relative costs change, the rate of exchange rate pass-through is decreasing in quality in high income countries, yet increasing in quality in low-income countries. We then document that these predictions receive empirical support in a dataset of prices and quality in the European car industry.

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Bibliographic Reference

Auer, R, Chaney, T and Saur�, P. 2014. 'Quality Pricing-to-Market'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10053