Abstract
We study firm-level pricing behavior through the lens of exchange rate pass-through and provide new evidence on how firm-level market shares and price complementarities affect pass-through decisions. Using U.S. import price micro data, we identify two facts: First, exactly the firms that react the most with their prices to changes in their own costs are also the ones that react the least to changing prices of competing importers. Second, the response of import prices to exchange rate changes is U-shaped in our proxy for market share while it is hump-shaped in response to the prices of competing importers. We show that both facts are consistent with a model based on Dornbusch (1987) that generates variable markups through a nested-CES demand system. Finally, based on the model, we find that direct cost pass-through and price complementarities among importers play approximately equally important roles in determining pass-through but also partly offset each other. This suggests that equilibrium feedback effects in import pricing are large. Omission of either channel in an empirical analysis results in a failure to explain how market structure affects price-setting in industry equilibrium.
•Micro data show that prices react to cost shocks and changing competitor prices.•Firms that react the most to changes in their own cost react the least to changing competitor prices.•Equilibrium pass-through is determined by the interplay of heterogeneity in reaction to own cost and competition.•Direct cost pass-through and indirect price complementarity channels play equally important roles.•Omission of either channel implies failure explaining how market structure affects price-setting in industry equilibrium.