How Does a Cost Shock Show in a Diagram
Cost Pass-Through to Buyers
Shock to Consumer Taste
A Look into Shock Pass-Through
We need to account for the fact that shocks can pass through from one side of the market to the other.
Almost No Pass-Through to Buyers
What does a “steep” supply curve mean?
Steep supply curve: supply changes only little when the price changes
- supply is price-insensitive or price-inelastic
What is the economics behind that?
- natural limits on capacity (e.g. oil)
- entry barriers
- scarce production factor (e.g. shipping)
Steepness depends on time horizon.
Almost Full Pass-Through to Buyers
What does a “steep” demand curve mean?
Steep demand curve: demand changes only little when the price changes
- demand is price-insensitive or price-inelastic
What is the economics behind that?
- Few available substitutes
- Essential (or addictive) products
- High-income buyers
Steepness depends on market definition
Caveat
The framework is relevant when
- Firms are relatively homogenous
- Shocks affect them in roughly uniform way
Not useful for studying an oil shock if firms use different technologies (e.g. some relying on green energy much more than others) Not useful for studying innovation if one firm’s innovation gives it competitive edge