Asymmetric price transmission
Encyclopedia
Asymmetric price transmission (sometimes abbreviated as APT and informally called "rockets and feathers" http://www.slate.com/id/2196273/http://www.knowledgeproblem.com/archives/001444.htmlhttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=978022) refers to pricing phenomenon occurring when downstream prices react in a different manner to upstream price
changes, depending on the characteristics of upstream prices or changes in those prices.
The simplest example is when prices of ready products increase promptly whenever prices of inputs increase, but take time to decrease after input price decreases.
Given the above, one might expect that:
Such behaviour, predicted by all canonical industry / market pricing models (perfect competition, monopoly) is called Symmetric Price Transmission.
In contrast to Symmetric price transmission, Asymmetric Price Transmission is said to exist when the adjustment of prices is not homogeneous with respect to characteristics external or internal to the system. As an example of Asymmetric Price Transmission consider a situation when:
One should remember that the size asymmetry (as illustrated by the bottom right panel of Figure 3) cannot occur on its own. If that had been the case the upstream price
s and downstream prices would drift apart. Since downstream prices and upstream prices are by definition related to each other, this cannot be the case. Accordingly, size asymmetry can occur only together with time asymmetry and only when the Long Run relationship between prices is restored after the impulse shock to upstream prices.
Firstly, its presence is not in line with predictions of the canonical economic theory (e.g. perfect competition
and monopoly
), which expect that under some regularity assumptions (such as non-kinked, convex
/concave
demand function) downstream responses to upstream changes should be symmetric in terms of absolute size and timing.
Secondly, because of the size of the some markets on which Asymmetric Price Transmission takes place (such as petroleum markets), global dependence on some products (again oil) and the share of income spent by average household on some products (again petroleum products), Asymmetric Price Transmission is important from the welfare
point of view. One must remember that APT implies a welfare redistribution from agents downstream to agents upstream (presumably consumers to large energy companies), it has serious political and social consequences.
The welfare redistribution effect (per unit of the good) is marked as a shaded area in Figures 1-3.
Upstream price
Upstream price is an economic term that refers to the price of main inputs of production or prices quoted on higher market levels...
changes, depending on the characteristics of upstream prices or changes in those prices.
The simplest example is when prices of ready products increase promptly whenever prices of inputs increase, but take time to decrease after input price decreases.
Terminology
In business terms, price transmission means the process in which upstream prices affect downstream prices. Upstream prices should be thought of in terms of main inputs prices (for processing / manufacturing, etc.) or prices quoted on higher market levels (e.g. wholesale markets). Accordingly, downstream prices should be thought of in terms of output prices (for processing / manufacturing, etc.) or prices quoted on lower market levels (e.g. retail markets).Background Theory
Since (by definition) upstream and downstream prices are related:- in absence of external shocks, some kind of economic equilibriumEconomic equilibriumIn economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...
relationship between those two should exist; - external shocks to the system (i.e. shocks to downstream or upstream prices) should trigger short- and long-run adjustment towards the long-run equilibrium, as:
- rational economic agents price their goods so as to maximize their constant utility function;
- in the long run prices of goods should reflect their scarcity.
Example of Price Transmission
Price transmission is best illustrated by an example. Assume that:- commodities analysed are:
- crude oil - global upstream, and
- petroleumPetroleumPetroleum or crude oil is a naturally occurring, flammable liquid consisting of a complex mixture of hydrocarbons of various molecular weights and other liquid organic compounds, that are found in geologic formations beneath the Earth's surface. Petroleum is recovered mostly through oil drilling...
- local downstream;
- market for petroleum in question is small compared to market for crude oil (in terms of quantities sold / bought), so that downstream prices cannot drive upstream prices;
- in the short run, only crude oil prices drive petroleum prices (i.e. prices of other inputs are assumed to be constant);
- no substitutes to petroleum are available in the short run.
Given the above, one might expect that:
- increases and decreases in crude oil prices trigger appropriate changes downstream;
- resulting changes are symmetric in terms of absolute size / timing.
Such behaviour, predicted by all canonical industry / market pricing models (perfect competition, monopoly) is called Symmetric Price Transmission.
In contrast to Symmetric price transmission, Asymmetric Price Transmission is said to exist when the adjustment of prices is not homogeneous with respect to characteristics external or internal to the system. As an example of Asymmetric Price Transmission consider a situation when:
- increases in crude oil prices lead to immediate increases in petroleum prices, but decreases in crude oil prices take time to be passed down to petroleum prices. This asymmetry is referred to as time asymmetry and is illustrated by the bottom right panel of Figure 1, or
- combination of the time asymmetry and the size asymmetry (i.e. a situation when increases in crude oil prices lead to bigger changes (in absolute values) in petroleum prices than decreases). This asymmetry is illustrated by the bottom right panel of Figure 2.
One should remember that the size asymmetry (as illustrated by the bottom right panel of Figure 3) cannot occur on its own. If that had been the case the upstream price
Upstream price
Upstream price is an economic term that refers to the price of main inputs of production or prices quoted on higher market levels...
s and downstream prices would drift apart. Since downstream prices and upstream prices are by definition related to each other, this cannot be the case. Accordingly, size asymmetry can occur only together with time asymmetry and only when the Long Run relationship between prices is restored after the impulse shock to upstream prices.
Consequences
The issue of Asymmetric Price Transmission received a considerable attention in economic literature because of two reasons.Firstly, its presence is not in line with predictions of the canonical economic theory (e.g. perfect competition
Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...
and monopoly
Monopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...
), which expect that under some regularity assumptions (such as non-kinked, convex
Convex function
In mathematics, a real-valued function f defined on an interval is called convex if the graph of the function lies below the line segment joining any two points of the graph. Equivalently, a function is convex if its epigraph is a convex set...
/concave
Concave function
In mathematics, a concave function is the negative of a convex function. A concave function is also synonymously called concave downwards, concave down, convex upwards, convex cap or upper convex.-Definition:...
demand function) downstream responses to upstream changes should be symmetric in terms of absolute size and timing.
Secondly, because of the size of the some markets on which Asymmetric Price Transmission takes place (such as petroleum markets), global dependence on some products (again oil) and the share of income spent by average household on some products (again petroleum products), Asymmetric Price Transmission is important from the welfare
Quality of life
The term quality of life is used to evaluate the general well-being of individuals and societies. The term is used in a wide range of contexts, including the fields of international development, healthcare, and politics. Quality of life should not be confused with the concept of standard of...
point of view. One must remember that APT implies a welfare redistribution from agents downstream to agents upstream (presumably consumers to large energy companies), it has serious political and social consequences.
The welfare redistribution effect (per unit of the good) is marked as a shaded area in Figures 1-3.