Product Heterogeneity, Exchange Rate And Export Price Pass-through

Comparied to the fluctuations in the exchange rate; international consumers are faced with relatively flatter fluctuations of prices. The reason is that, export enterprises would adjust their export prices and quantity according to exchange rate. By adjusting profit markup of export enterprise, the import prices (denominated in currency of importing country) are relatively more stable. In other words, export enterprises initiatively take part of the risk of exchange rate fluctuations.The decision of export products’ price is directly related to product characteristics. We would explore the different determinants of exchange rate pass-through theoretically, as well as through empirical research.Our model is based on the heterogeneity in product level, and we explored how enterprises adjust prices of export products (denominated in local currency) and the export quantity when they were faced with the change of exchange rate.Through the model of optimal pricing decision, we found that the exchange rate fluctuations affect the marginal cost of export products and the markup, which affects export pricing decisions of the export enterprises. In our Model, we identify the het-erogeneity in the level of produce from the perspective of demand and cost. In terms of demand, product heterogeneity is embodied in the quality of the products while in terms of production levels, product heterogeneity is reflected in enterprise production efficiency and the different proportion of foreign intermediates, which further shows the cost difference.Based on the product level, we do some empirical research with China’s manufacturing industry customs export data in 2002-2006. Our empirical analysis is based on level of export enterprise-importer-products. In terms of the overall sample, when the real exchange rate of RMB appreciated 10%, China’s export enterprises would reduce about 2.5% of prices (in RMB), which means that the exchange rate pass-through effect is about 75%. In terms of demand, the higher the quality of the product and the higher income level of importer, the smaller elasticity of the demand price for the export products. As a result, the elasticity of RMB export price related to exchange rate volatility would be larger. In terms of production, if export enterprises imported more foreign intermediates in the production, or the higher efficiency of production, the bigger fluctuations impact exchange rate would have on the cost of production and export enterprises profit bonus. The greater the elasticity of export price in local currency related to exchange rate fluctuations, the more incomplete pass-through exchange rate would have, under incomplete Exchange rate pass-through, in order to providing stable commodity price (in foreign currency) in importer market, export enterprises choose not to transfer all volatility risk of exchange rate to import enterprise, but to adjust profit and take part of the risk of exchange rate fluctuations. Relevant policy should be introduced, such as corresponding currency derivative financial products, to reduce the currency risk for the export enterprises.