A merger that permits the combined company to reduce the marginal cost of producing a product creates an incentive for it to lower price. Accordingly, the rate at which cost changes are passed through to prices (along with an estimate of the magnitude of cost reductions that would result from merger) matters to the evaluation of the likely competitive effects of an acquisition. In this paper, we describe our empirical methodology for estimating the cost pass-through rate facing an individual firm, and for distinguishing that rate from the rate at which a firm passes through cost changes common to all firms in an industry. In essence, we regress the price a firm charges on both its costs and the costs of another firm in the industry. Including the second cost variable allows us to estimate the impact of costs on prices while holding constant that part of cost variation due to industry-wide cost shocks.
Jonathan Baker, Orley Ashenfelter, David Ashmore & Signe-Mary McKernan,
Identifying the Firm-Specific Cost Pass-Through Rate,
Federal Trade Commission. Bureau of Economics
Available at: https://digitalcommons.wcl.american.edu/facsch_lawrev/1910