Asymmetric cost pass-through? Empirical evidence on the role of market power, search and menu costs

Abstract

We estimate cost pass-through rates based on data for store-level retail prices and wholesale costs for up to 90 different brands of milk sold in 327 retail stores across Germany. The abundance of the data allows us to identify heterogeneity in pass-through across retailers and relate it to underlying explanatory factors such as retailer market power, measures of consumer search and menu costs. Results from a threshold-error-correction-process clearly provide empirical support for the ‘rockets and feathers’ phenomenon: prices increase more quickly than they decrease. In contrast to much of the existing literature, which explains the ‘rockets and feathers’ phenomenon as a result of retailers exercising market power, we find the opposite result: the degree of asymmetry in prices is negatively related to market power (decreases with the Lerner-Index). Our measure of (cross-product) search costs does not account for observable differences in asymmetric cost pass-through rates between products. The ‘rockets and feathers’ observation is better explained by product-specific differences in menu costs (‘mistake costs’) and costs associated with stock-outs which can lead to a loss of consumer goodwill.