Asymmetric Demand Effects and Cost Pass-Through

Abstract

We build a model to analyze the cost (wholesale price) pass-through incentives of a retailer selling two products. The products, `leader' and `follower,' are such that the leader's price affects the follower's demand, but not vice versa. These products could be in different categories, such as a featured soft drink and chewing gum near the register, or they could be in the same category, such as a national brand and a generic alternative. In each case, we find that the retailer has stronger incentives to pass-through trade deals to consumers on the leader product, and weaker incentives to pass-through on the follower product. We outline the intuition of these results and show that the incentive to pass-through on the leader product increases with retail competition. We show that in the monopoly case with linear demand, the pass-through rates add up to one, with the leader's being larger, and that higher demand elasticity due to peak demand reduces the difference between the pass-through incentives associated with each type of product, resulting in more similar pass-through rates. In the duopoly case with linear demand, competition increases the pass-through rate of the leader, decreases the pass-through rate of the follower, and makes the sum of the pass-through rates larger than one.