Preistransmission

What Is Preistransmission?

Preistransmission, also known as price transmission, refers to the process by which changes in prices at one level or segment of a market or economy influence prices in other related levels or segments. This concept is fundamental to Economics and Macroeconomics, explaining how initial price shocks, whether from raw materials, production costs, or policy changes, ripple through supply chains and across different markets. Effective Preistransmission ensures that price signals are accurately conveyed, allowing market participants to adjust their behavior.⁷³, ⁷⁴

The extent and speed of Preistransmission can vary significantly depending on factors such as market structure, competition, and the nature of the goods or services involved. For instance, a change in wholesale prices for an agricultural commodity might transmit differently to retail prices compared to how a change in interest rates transmits through financial markets. Understanding Preistransmission is crucial for analyzing market dynamics, forecasting inflation, and designing effective economic policies.

History and Origin

The concept of price transmission has deep roots in economic theory, particularly linked to the "Law of One Price" (LOP). The LOP, dating back to economists in the 1760s-1770s, posits that in efficient and frictionless markets, identical goods should have the same price globally when expressed in a common currency, with differences only accounted for by transportation and transaction costs.⁷⁰, ⁷¹, ⁷² This theoretical underpinning suggests perfect and instantaneous price transmission.

Over time, empirical studies revealed that perfect price transmission is rarely observed in real-world markets. Research on price transmission gained significant traction with the development of econometric techniques capable of analyzing how price changes propagate through various stages of supply chain and across different markets. For example, the Federal Reserve Bank of San Francisco published analysis on how oil price shocks transmit to inflation and how monetary policy reacts to such shifts, highlighting the practical importance of understanding these mechanisms. [FRBSF_OilMonetaryPolicy] Early research often focused on agricultural markets, examining how farm-gate prices translated into wholesale and retail prices, and later expanded to analyze broader economic phenomena like the transmission of global commodity prices to domestic consumer prices.⁶⁹

Key Takeaways

Preistransmission describes how price changes spread from one market or stage of production to another.
It is a core concept in economics, helping to explain market dynamics and inflationary pressures.
The degree and speed of Preistransmission are influenced by market structure, competition, costs, and policy interventions.
Preistransmission can be symmetric (prices rise and fall at similar rates) or asymmetric (prices react differently to increases versus decreases).
Understanding Preistransmission is vital for policymakers, businesses, and consumers to anticipate and respond to market shifts.

Interpreting Preistransmission

Interpreting Preistransmission involves assessing how completely, quickly, and symmetrically price changes are passed through different market levels or across borders. When Preistransmission is "complete," it implies that a percentage change in an input price or an upstream market price results in an equivalent percentage change in the output price or a downstream market price. In reality, complete Preistransmission is rare due to various market frictions.⁶⁷, ⁶⁸

The "speed" of transmission refers to how quickly price changes in one segment are reflected in another. Delays can occur due to factors like inventory levels, contractual agreements, or market power. "Asymmetric price transmission" is a common observation, where downstream prices may react more quickly or fully to input price increases than to input price decreases.⁶⁵, ⁶⁶ This "rockets and feathers" phenomenon is frequently observed in markets like gasoline, where pump prices might jump quickly with rising crude oil costs but fall more slowly when crude prices decline. Analyzing these characteristics helps identify potential market inefficiencies, diagnose sources of price stickiness, and evaluate the effectiveness of policy interventions.⁶⁴

Hypothetical Example

Consider a hypothetical scenario involving the global coffee market. Suppose a major drought in Brazil, a leading coffee producer, severely reduces its coffee bean harvest. This economic shock immediately drives up the global wholesale price of raw coffee beans due to decreased supply and unchanged demand.

Step-by-step Preistransmission:

Initial Shock (Wholesale Level): The price of unroasted coffee beans on international commodity exchanges rises sharply.
Processor Level: Coffee roasters, who buy the raw beans, face higher input costs. To maintain their margins, they begin to increase the prices they charge to distributors and retailers for roasted coffee.
Retailer Level: Coffee shops and grocery stores that purchase roasted coffee or ground coffee from processors face increased costs. They, in turn, adjust their shelf prices for coffee products and the cost of a cup of coffee.
Consumer Level: Consumers ultimately experience higher prices for their morning brew or bags of coffee at the supermarket.

The speed and extent to which these price increases are felt at each stage illustrate Preistransmission. If local cafes quickly raise prices after hearing about the drought, that's fast transmission. If prices rise more than proportionately for consumers, it might indicate market power at intermediate stages or other inefficiencies in the supply chain.

Practical Applications

Preistransmission is a critical concept with numerous practical applications across various sectors of the economy:

Monetary Policy: Central banks closely monitor Preistransmission to understand how changes in interest rates or other monetary policy tools affect aggregate demand, asset prices, exchange rates, and ultimately, the general price level (inflation).⁶³ For instance, the Federal Reserve analyzes how oil price fluctuations transmit through the economy and influence inflation, which then informs policy decisions. [FRBSF_OilMonetaryPolicy, 11]
Agricultural and Food Markets: Understanding how price changes for agricultural commodities transmit from farm gate to wholesale to retail is crucial for ensuring food security and assessing market fairness. Factors like transportation costs, processing margins, and government subsidies all influence this process.⁶¹, ⁶² The International Monetary Fund (IMF) has highlighted how global food price changes are transmitted to local markets, particularly impacting regions like Sub-Saharan Africa due to import reliance. [IMF_FoodPricesAfrica, 18]
Energy Markets: The transmission of crude oil prices to retail gasoline and other energy products is a key area of study. During Europe's energy crisis, the rise in wholesale gas prices quickly translated into higher electricity and heating costs for households and businesses, fueling broader inflation. [Reuters_EuropeEnergy, 29]
Business Strategy: Businesses analyze price transmission to forecast input costs, optimize pricing strategies, and manage risk. Companies in a competitive market may have less control over passing on cost increases than those with significant market power.
International Trade: In globalized financial markets, Preistransmission explains how international price shocks for commodities or currencies can impact domestic prices, affecting trade balances and consumer purchasing power.⁶⁰

Limitations and Criticisms

Despite its importance, the concept of Preistransmission faces several limitations and criticisms in its practical application:

Market Imperfections: Real-world markets are rarely perfectly competitive. Market segmentation, information asymmetry, and the existence of oligopolies or monopolies can impede or distort the smooth transmission of prices. Powerful intermediaries in a value chain might absorb price changes to protect their margins, leading to incomplete transmission to producers or consumers.⁵⁶, ⁵⁷, ⁵⁸, ⁵⁹
Asymmetry: Asymmetric price transmission (APT), where prices respond differently to increases versus decreases, is a widely observed phenomenon that challenges the ideal of smooth transmission. Reasons for APT include inventory management, consumer search costs, and non-linear adjustment costs for firms.⁵⁵
Transaction and Policy Costs: High transaction costs, such as transportation, storage, or regulatory compliance, can create "wedges" between prices in different markets, preventing full Preistransmission and allowing for significant price differentials even for identical goods. Government policies like subsidies, tariffs, or price controls can also intentionally or unintentionally distort price signals and limit transmission.⁵², ⁵³, ⁵⁴
Measurement Challenges: Accurately measuring Preistransmission can be complex due to data limitations, the intricate nature of modern supply chains, and the need for sophisticated econometric models to capture non-linear relationships.⁵⁰, ⁵¹ The presence of multiple factors influencing prices simultaneously makes isolating the transmission effect challenging.⁴⁹
Dynamic and Lagged Effects: Price transmission is rarely instantaneous. Time lags in adjustment can arise from contractual obligations, delayed information, or behavioral responses, making it difficult to predict the precise effect of a shock.⁴⁷, ⁴⁸

These limitations mean that while Preistransmission provides a valuable framework for understanding market dynamics, its real-world manifestation is often imperfect and highly nuanced.

Preistransmission vs. Price Discovery

While both Preistransmission and Price Discovery relate to how prices are formed and behave in markets, they describe distinct processes.

Preistransmission focuses on how a change in price in one market or stage of a supply chain affects prices in other related markets or stages. It describes the propagation or ripple effect of an existing price movement. For example, if the global price of crude oil increases, Preistransmission explains how that increase translates into higher gasoline prices at the pump.

Price Discovery, on the other hand, refers to the overall process by which the equilibrium price for an asset or commodity is determined in a market, typically through the interaction of buyers and sellers reacting to new information, supply and demand dynamics, and trading activity. It's about how a price is established in the first place, or how it finds its new equilibrium in response to new information. For example, the constant bidding and asking in a stock market or a commodity exchange is a process of price discovery.

In essence, price discovery determines the initial price at a given point in time or market, while Preistransmission explains how that discovered price (or its change) then influences prices elsewhere. Preistransmission often relies on the outcomes of price discovery in an upstream market.

FAQs

What are the main types of Preistransmission?
Preistransmission can be categorized as vertical (e.g., farm-to-retail prices in a supply chain), horizontal or spatial (e.g., price changes between geographically separated markets), or inter-commodity (e.g., the price of one commodity affecting a substitute or complementary commodity).⁴⁵, ⁴⁶

Why is Preistransmission important for consumers?
For consumers, understanding Preistransmission helps anticipate how changes in global or wholesale prices for goods like food or energy will eventually impact their household budgets. It explains why the cost of living can rise even if their immediate purchasing behavior hasn't changed.⁴⁴

How do government policies affect Preistransmission?
Government policies, such as subsidies, taxes, tariffs, or price controls, can significantly influence Preistransmission. They can act as buffers that dampen the transmission of price shocks or, conversely, as accelerators that amplify them. For example, a fiscal policy involving food subsidies might prevent global food price increases from fully transmitting to domestic retail prices.⁴¹, ⁴², ⁴³

What is asymmetric price transmission?
Asymmetric price transmission (APT) occurs when prices respond differently to increases in input costs than to decreases. For example, retail prices might rise quickly when wholesale costs go up ("rockets") but fall slowly when wholesale costs come down ("feathers").⁴⁰ This phenomenon can be influenced by factors like market power, inventory management, and consumer behavior.

Can Preistransmission be incomplete?
Yes, Preistransmission is often incomplete in real markets. This means that a change in an input price or upstream market price is not fully passed through to the downstream price. Factors like market inefficiencies, transaction costs, and market power can lead to incomplete transmission.³⁸, ³⁹ ¹, ² ³ ⁴, ⁵, ⁶ ⁷[⁸](https://ageconsearch.umn.edu/nanna/record/211832/files/Karikallio-Cross-commodity%20Price%20Transmission%20and%20Integrati[³⁶](https://www.adb.org/sites/default/files/publication/28900/economics-wp257.pdf), ³⁷on-814.pdf?withWatermark=0&withMetadata=0&registerDownload=1&version=1), ⁹ ¹⁰, ¹¹ ¹² ¹³, ¹⁴ ¹⁵, ¹⁶, ¹⁷ ¹⁸ ¹⁹, ²⁰, ²¹, [²²](https://cris.unibo.it/retrieve/e1dcb337-fba5-771[³³](https://www.adb.org/sites/default/files/publication/28900/economics-wp257.pdf), ³⁴, ³⁵5-e053-1705fe0a6cc9/sustainability-13-09172.pdf)²³ ²⁴, ²⁵ ²⁶ ²⁷ ²⁸, ²⁹ ³⁰, ³¹ ³²