Input Complementarity Implies Output Elasticities Larger than One: Implications for Cost Pass-Through

Abstract

When inputs in the firm’s production function are pair-wise complements, I show that all variable factors of the firm are output elastic. Via Silberberg’s analysis, this implies that for given output of a competitive firm that marginal cost will rise more than average cost for a factor price increase. Accounting for changes in output through profit maximization and industry equilibrium change in output price, I show that cost pass-through can be larger than one in a competitive industry when inputs are complementary. Because input complementarity seems likely with commodity aggregates like materials, labor, energy, and capital, this could provide an alternative explanation for over cost shifting in commodity-oriented industries like the oil industry and food industries. This approach also allows researchers to abandon the highly restrictive assumption of constant elasticity of demand function facing the firm that is required under imperfect competition with constant marginal costs.