DP15475 Constant Pass-Through

Author(s):	Kiminori Matsuyama, Philip Ushchev
Publication Date:	November 2020
Keyword(s):	Constant Elasticity of Substitution (CES), Constant Pass-Through (CoPaTh), Constant Price Elasticity (CPE), H.D.I.A., H.I.I.A., H.S.A., Heterogenous firms, Homothetic Demand Systems, monopolistic competition
JEL(s):	D21, D43, L13
Programme Areas:	Industrial Organization, International Trade and Regional Economics, International Macroeconomics and Finance, Monetary Economics and Fluctuations, Macroeconomics and Growth
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=15475

We propose and characterize parametric families of homothetic demand systems, which feature a constant pass-through rate that is common across otherwise heterogenous monopolistically competitive firms. These parametric families offer natural, flexible, and yet tractable extensions of CES. In the case of complete pass-through, the markup rate is constant, as in CES, yet it can be heterogenous across firms, unlike in CES. In the case of incomplete pass-thorough, the price of each firm is log-linear in its marginal cost and its choke price with the common coefficients across firms. Tougher competition, captured by a lower "average price," reduces the prices of all firms at a uniform rate, and hence without affecting their relative prices. Yet, it causes a disproportionately larger decline in the revenue and the profit among firms with lower markup rates.