Production value chains are characterized by complex interactions between firms, both within and across country borders. A burgeoning literature recognizes that these interactions often involve granular buyers and suppliers of intermediate goods that exert market power over prices. However, we know surprisingly little about how two‐sided market power influences the outcomes of these relationships. How are prices determined in bilateral negotiations? How does market structure influence the propagation of shocks within a domestic network of firms? Exploring the underlying structure of buyer‐supplier negotiations can help us shed light on the welfare impact of aggregate and firm‐level shocks.
This project leverages detailed firm‐to‐firm transaction data from Chile to answer these questions. A unique feature of this data is that it contains information on the prices and quantities negotiated between each firm and its whole network of foreign and domestic suppliers. We combine this data with an industry equilibrium model of price‐setting in the presence of two‐sided market power that builds on recent work by Alviarez et al. (2021). Our model (i) generates predictions on the equilibrium relationship between negotiated prices and bilateral market shares (ii) can be used to study equilibrium markup response to aggregate and firm‐level shocks in a network of firms.
We believe that having a better picture of the interrelationship between market power and price setting can help governments better understand and predict the propagation of shocks through firm networks. Being able to predict how shocks will be passed through to prices depending on the characteristics of shocked firms and their network of trade partners relevant to design financial, fiscal, and monetary policies in response to these shocks. One further implication of our work is that competition and trade policy might have a key role to play in governing the distribution of rents in firm networks. Our project will shed light on how rents are distributed between input buyers and sellers depending on the market power that each side possesses. Although we abstract from dynamic considerations in this paper, we think that understanding how two‐sided market power affects rent distribution across firms might be important to understand incentives for innovation in the economy, and to better design policies that promote aggregate growth.
In our work, we find empirical evidence on the relationship between bilateral supplier and buyer shares and prices in firm‐to‐firm transaction networks. Suppliers charge lower pricesto their largest buyers, and input buyers receive higher prices from their key suppliers. To understand the equilibrium effects of an international trade shock on a domestic network of input suppliers and buyers, we perform empirical simulations on a network that replicates the main features of the Chilean firm‐to‐firm network and behaves under the price‐setting assumptions of our model. We show that, in the face of a 16% simulated increase in foreign input costs, domestic downstream firms increase their domestic input purchases by 12% on average. Further, the increase in domestic input purchases leads to an average 1.2% increase in the markups negotiated by domestic suppliers in our simulations. This average increase masks significant heterogeneity in negotiated markups: we observe that small but dedicated input domestic suppliers increase their markups by almost twice as much as the average response. In future work we plan to estimate our empirical model leveraging variation in our transaction data. We will use the model to assess whether market structure has played the role in the propagation of recent disruptions in global trade