Firm types, price-setting strategies, and consumption-tax incidence

Abstract

We analysize price responses to large restaurant VAT rate reductions in two different European countries. Our results show that price responses in the short and medium run were clustered around two focal points of zero pass-through and full pass-through. Differences between independent restaurants and chains is the key explanation for this pattern. While nearly all independent restaurants effectively ignored the tax reductions and left consumer prices unchanged, a substantial fraction of restaurants belonging to chains chose a rapid and complete pass-through. In the longer run, prices concerged, but primarily through a price reversion among chain restaurants. The stark difference in price responses cannot be explainded by market characteristics such as location, initial price levels, meal types or restaurant types. Further evidence on the use of round-number pricing, on price-change frequencies, and on pricing behavior during currency conversions suggets that the diverging price responses to consumption-tax reform instead reflect fundamental differences in price-setting behavior between the two types of firm.

• ISSN: 1795-1801 (Online)
• ISBN: 978-952-209-159-8 (Online)
• JEL: H22, H32, E31
• Publication in PDF-format