Milking the Demand Curve: Consumer and Firm Behavior in Inflationary Times

We study the effect of the recent inflationary environment on consumer and firm behavior in the Austrian market for milk. Combining detailed scanner data on households' milk purchases with farm-gate raw milk prices, we document sharp increases in both producer and consumer milk prices, as well as above-unity pass-through, at the onset of the inflationary episode. We rationalize these patterns via an estimated model of demand and supply. Consistent with some theoretical predictions, exposure to inflation reduces households' price sensitivity. This channel explains nearly 30% of the observed increase in prices and the bulk of the increase in retailers' margins in 2022. Retailer coordination is not needed to explain the observed data patterns and, in particular, the overshifting of costs to retail prices. Nonetheless, counterfactual analyses reveal that a more competitive retail sector would have dampened the response of milk prices to the inflationary shock.