Working Paper

Prices, markups, and exchange rates

Chen, N, Juvenal, L, Martinez, A; (2026) Prices, markups, and exchange rates, Centre for Inclusive Trade Policy, Working Paper 046

Published 11 November 2026

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CITP Working Paper 046

Abstract

Using highly disaggregated data for Colombian manufacturing firms during a large depreciation episode, we decompose firm-product prices into marginal cost and markup components to document new stylized facts about how exchange rate changes impact domestic prices. First, by weakening the intensity of import competition, a depreciation increases markups and, therefore, prices. Second, a depreciation raises marginal costs, but the resulting price increases are more modest because firms use their market power to partially offset the cost increases by reducing markups. These empirical patterns can be predicted by trade models featuring subconvex demand systems. They are important for understanding how exchange rate fluctuations affect domestic prices and, in turn, inflation.

Non Technical Summary

When a country’s currency loses value, imported inputs and competing foreign goods become more expensive. How much these changes affect the prices of domestically produced goods is a key question for central banks and policymakers. There are two channels through which exchange rate changes can affect domestic prices: by affecting firms’costs by changing the prices firms pay for imported inputs and by changing firms’ markups (margins) by affecting the degree of import competition in the domestic market. As both marginal costs and markups are typically unobserved in the data, this paper estimates both for Colombian manufacturing firms during a large currency shock. This allows to investigate the channels through which changes in exchange rates affect domestic prices.

Between 2014 and 2015, as oil prices fell, the Colombian peso lost about a third of its value against the US dollar. Because Colombia pays for most of its imports in dollars, this sharply raised the peso cost of imported materials and of competing imports. We use data from the Colombian statistical agency (DANE) on the universe of manufacturing plants with ten or more employees between 2009 and 2019. Crucially, the data reports the physical quantities of every product firms make and every input they use. This allows us to estimate the production cost and the markup of each product manufactured by each firm, and to split prices into cost and markup components.

We find that a depreciation affects markups through two opposing channels. The first is a cost channel. A weaker peso makes imported inputs more expensive, raising production costs, but firms do not pass through the full increase in costs to customers: they absorb part of it by accepting lower markups. After the 2014–2015 depreciation, production costs rose by about 9%, prices by about 6.5%, and markups fell by about 2.7%. The second is a competition channel. A weaker peso makes competing imports more expensive, easing foreign competition on the domestic market. Comparing firms with the same production costs, we find that this allowed domestic producers to raise markups by roughly 2 to 3%. The effect also holds for firms that only sell in Colombia (i.e., firms that do not export), confirming that it reflects weaker import competition.

The balance between the two channels differs across firms and products. Importers faced the largest cost increases and the greatest squeeze on margins. Firms with high markups before the shock, as well as larger firms, absorbed much of their cost increase into their margins, while firms with low markups gained most from weaker competition. At the same time, larger firms also benefited more from reduced competition. Across products, goods closer to the input stage of production faced the largest cost increases. These are intermediate goods, goods with a reference price, and goods traded on organized exchanges such as commodities. By contrast, the competition channel was strongest for goods traded on organized exchanges and, to a lesser extent, for consumer goods, where domestic and imported varieties are close substitutes.

These responses matter for inflation. The depreciation raised inflation for domestically produced manufacturing goods by about 1.9 percentage points in 2016 and 0.8 percentage points in 2017. As these goods make up roughly a quarter of the consumer basket, this accounts for around 6% of Colombia’s consumer price inflation over those two years. The effect came almost entirely through higher costs: the depreciation changed the level of markups but did not persistently change the growth of markups over time.

The findings carry clear policy lessons. For central banks, how a currency depreciation feeds into inflation depends on firms’ reliance on imported inputs and on the competition they face, not on a single average pass-through rate. For trade and competition policy, import competition affects domestic prices: when it weakens, firms with market power raise their markups, and consumers bear the cost.