Cost Pass-Through in Strategic Oligopoly: Sectoral Evidence for the EU ETS

The purpose of this paper is to analyse the cost pass-through potential, i.e. the ability of firms in German industrial sectors participating in the EU Emissions Trading Scheme (EU ETS) to adjust output prices to input cost shocks. The analysis is as comprehensive as the data permits and covers industrial branches paper and pulp, chemicals, rubber and plastic and non-metallic minerals. Although strategic interactions of domestic energy-intensive sectors with foreign competitors might be of importance, empirical cost pass-through literature does typically not take them into consideration. The stylised theoretical and empirical framework in this paper employs therefore a variant of the mark-up model of price determination which allows for strategic interactions between domestic and foreign firms. The key feature of the model is that the cost pass-through of domestic firms is limited by strategic considerations. The empirical section demonstrates that strategic pricing in the presence of the incomplete cost pass-through is by far the prevailing behaviour of German sectors within the EU ETS. We find that high market power of domestic firms in relatively homogenous product markets leads to lower cost pass-through rates and to the more pronounced adjustment towards the foreign producers' prices. The higher the market concentration of domestic firms in more heterogeneous product markets, the higher the cost pass-through potential and the lower strategic interactions with foreign enterprises.

Alexeeva-Talebi, Victoria (2010), Cost Pass-Through in Strategic Oligopoly: Sectoral Evidence for the EU ETS, ZEW Discussion Paper No. 10-056, Mannheim.