Firm specific pass through and heterogeneity

In this paper, a simple and tractable model of cost pass through is presented to explain the rate of transmission of exchange rate variations to the markups of exporting firms. The explanation is based on the assumption of endogenous firms, endogenous markups and variable marginal cost. A key feature of the model is that pass-through is firm-specific and depends on the degree of firm’s technology of production. The model predicts that high performance firms have higher markups as they pass more their cost into their exporting prices. It is also found out that in response to an exchange rate variation higher performance firms tend to absorb more these changes into their markups. The predictions of the model confirmed by the empirical evidence on the firm-level data of non-petroleum manufacturing of Iran over the period of 2002-2007.