Price transmission and cost pass-through on the German dairy value chain

The formation of value chains is among the central issues in the development of the global trade. This study sheds light on the various price relationships and extends the existing literature on vertical and horizontal price transmission by investigating the causal structures on international dairy markets and their relationships with national wholesale and retail prices in Germany. Methodologically, the study is based on the law of one price, which states that identical goods should have identical prices. Price dynamics are modelled with modern panel and time series models that cope with non-stationary variables. The analysis employs store-level retail scanner data and prices for major international skim milk powder and butter markets. The results suggest that world market prices lead German wholesale prices, which pass on to farmers and retailers. Private label retail prices closely follow the price developments of standard milk products on the world markets. Manufacturer brands product prices deviate from world market trends. At the producer level, raw milk is an almost homogeneous product. The price of raw milk strongly correlates with international skim milk powder and butter markets. Processing creates a multitude of different products. At the retail level, we observe thousands of different products and brands; thus, the complexity of price relationships vastly increases towards the end of the value chain, which enables firms to pass on idiosyncratic costs or to generate extra profits.