Pass-Through in Levels and the Incidence of Commodity Shocks

Abstract

Empirical studies find that the pass-through of commodity price movements to downstream prices is incomplete: a 10 percent increase in upstream costs causes downstream prices to rise less than 10 percent, even at long horizons. Using microdata from gasoline and food products, we find that incomplete pass-through in percentages often disguises complete pass-through in levels: a $1/unit increase in commodity costs leads to $1/unit higher downstream prices. Pass-through appears incomplete in percentages due to a gap between prices and costs. This pass-through behavior, as well as other evidence on firm gross margins, operating margins, and entry rates, contrasts with workhorse models that feature fixed, multiplicative markups. An implication of complete pass-through in levels is that rising commodity costs lead to higher inflation rates for low-margin products in a category, though absolute price changes are similar across products. This generates cyclical inflation inequality. From 2020–2023, we estimate that this pass-through behavior is responsible for two-thirds of the gap in food-at-home inflation rates experienced by low- and high-income households. 

Keywords: pass-through, commodity shocks, inflation

JEL Classification: E31, D22, D40, E32, L11