Introducing profit margins into the aggregate
equation allows more flexibility in the speed and
amount of pass-through of exchange rate
changes to import prices. But what factors can
lead to variable profit margins? Profit margins
vary in part because of the characteristics of
market structure in the individual industries and
in part because of overall changes in the macroeconomic
environment.
A number of models of international trade
analyze how prices are affected by market structures
that deviate from perfect competition. Factors
leading to imperfect competition include
imperfect substitutability of products so that
each supplier has some market power; production
technology that exhibits nonconstant returns
to scale so that the supply curve is sloped; a
relatively small number of firms in the industry;
and wage and sales contracts that may limit the
speed of adjustment of prices to changes in costs
or demand.2