Working Paper: CEPR ID: DP10053
Authors: Raphael Auer; Thomas Chaney; Philip Saur
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.
Keywords: exchange rate pass-through; intra-industry trade; monopolistic competition; pricing-to-market; vertical differentiation
JEL Codes: E3; E41; F12; F4; L13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| market income (E25) | pricing strategies (D49) |
| quality (L15) | pricing strategies (D49) |
| quality (L15) | exchange rate pass-through (F31) |
| market income (E25) | exchange rate pass-through (F31) |
| pricing strategies (D49) | price differentials (L11) |
| quality (L15) | price differentials (L11) |