Pass-through with Price Dispersion

Abstract

How do cost shocks pass through to prices in markets with price dispersion? Pass-through analysis typically assumes a single equilibrium price, but empirical studies consistently document substantial price variation, even for homogeneous products. This paper develops a tractable framework that decomposes the pass-through problem into two distinct tiers. The first is a competition layer where consumers' consideration sets determine equilibrium distributions of normalized margins. The second is a curvature layer where demand elasticity determines how these margins translate into prices and pass-through rates. The key theoretical innovation is showing that the strategic pricing game with arbitrary downward-sloping demand is order-isomorphic to a baseline unit-demand game once reformulated in terms of normalized effective margins. This decomposition yields closed-form pass-through formulas, robust bounds across demand specifications, and clear comparative statics linking market structure to incidence.