Price transmission: the interaction between market power and returns to scale

Recent literature emphasises the role of market structure in determining the degree of price transmission along the marketing chain, the presumption being that if downstream markets are imperfectly competitive price transmission will be less than complete. However, empirical studies of market power often ignore the role of the underlying cost conditions. This paper shows that if an industry is characterised by non-constant marginal costs, there can be a significant impact on price transmission. Specifically, it is shown that the nature of the returns to scale that characterise the food industry cost function may either increase or decrease the degree of price transmission. Under certain conditions, price transmission may be greater in industries with increasing returns to scale than in markets characterised by perfect competition and constant returns to scale.