In economics, cost pass-through (also known as price transmission[1] or simply pass-through[2]) is a process (or result) of a business changing pricing of its output (products or services) to reflect a change in costs of its own input (materials, labor, etc.).
[3] In the studies of inflation, an opposite direction pass-through from prices to wages is also considered, as well as both occurring together (wage-price spiral).
In the case of a perfectly elastic demand (consumers ready to abandon the market if faced with any price increase), producers will be forced to fully absorb the shock (pass-through rate 0.0).
[7] In the intermediate case of consumers being somewhat price-sensitive, the demand for goods will be reduced; the ultimate pass-through effect will be dependent on the slope of the supply curve.
If the supply curve slopes downward (case of economy of scale), reduced production will make each unit costlier to produce, so the pass-through rate can become higher than 1.0 (so called over-shifting).
[7] In addition to the absolute pass-through that uses incremental values (i.e., $2 cost shock causing $1 increase in price yields a 50% pass-through rate), some researchers use pass-through elasticity, where the ratio is calculated based on percentage change of price and cost (for example, with elasticity of 0.5, a 2% increase in cost yields a 1% increase in price).
In an oligopolistic market cost shocks experienced by one producer affect the competitors through a change in equilibrium price (so called cross pass-through effect).
This asymmetry eventually dissipates, although there is no set time interval for this downward adjustment of the price.
[14] There are few ways to estimate (or predict) the pass-through rate:[15] The attempts to accurately estimate the cost pass-through are hampered by multiple practical issues: Empirical data on pass-through values shows large variability both between the particular industry cases and between different companies affected by similar price shocks: absolute industry-wide passthrough rate were observed to be anywhere between 20% and way above 100%, with pass-through elasticities occupying the full range of 0.0 to 1.0 (elasticities close to 1.0 in practice correspond to absolute rates above 100% due to mark-up inherent in a successful business operation).