Production value chains are characterised by complex interactions between firms, both within and across country borders. Raw products tend to go through several different intermediate businesses before being sold to a customer. A burgeoning literature recognises that these interactions often involve granular buyers and suppliers of intermediate goods that exert market power over prices. However, surprisingly little is known 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 shed light on the welfare impact of aggregate and firm-level shocks.
This project leverages detailed firm-to-firm transaction data from the Internal Revenue Service of Chile to answer these questions. A unique feature of this data is that it contains information on the prices and quantities negotiated between each and every firm and its whole network of foreign and domestic suppliers. This data is combined with an industry equilibrium model of price-setting in the presence of two-sided market power. The model generates predictions on the equilibrium relationship between negotiated prices and bilateral market shares. It can also be used to study equilibrium markup response to aggregate and firm-level shocks in a network of firms.
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. Understanding how shocks will be passed through to prices depending on the characteristics of firms and their trade network is highly relevant to the design of financial, fiscal, and monetary policies implemented to counter these shocks. Additionally, competition and trade policy might have a key role to play in governing the distribution of rents in firm networks. This project sheds light on how rents are distributed between input buyers and sellers depending on the market power that each side possesses. This is important to understand when designing incentives for innovation in the economy and policies that promote aggregate growth. While the project is based in Chile, international trade and natural resources are the basis of many lower-income countries. Firm transactions may have similar characteristics across these economies, allowing policy lessons learned in this project to be widely applicable.