Passing through the supply chain: Implications for market power

Abstract

In this paper, we study the connection between pass-through and market power in the Brazilian Liquefied Petroleum Gas (LPG) industry. We use a state tax shock and apply a difference-in-differences strategy to estimate pass-through – at different levels of the supply chain – and an instrumented difference-in-differences strategy to estimate demand, and then feed a theoretical model to make inferences about a conduct parameter – that measures market power. We find an incomplete pass-through at the distribution level and for the supply chain as a whole, and a more-than-complete one at the retail level. Furthermore, we estimate price-elasticity of demand to be greater than one. When we feed a theoretical model of pass-through under imperfect competition with these estimates, we obtain a high conduct parameter at the whole supply chain level and an even higher one at the retail level alone. These results show that considering only the whole supply chain pass-through may lead to hasty conclusions about market power. Besides contributing to the empirical literature that connects pass-through with market power, we contribute to on-going national discussions regarding competitiveness in the LPG industry.