Empirical studies find that the pass-through of input cost changes to prices is incomplete: a 10% increase in costs causes downstream prices to rise less than 10%, even at long horizons. Using microdata from gas stations, food products, and manufacturing industries, I find that incomplete pass-through in percentages often disguises complete pass-through in levels: a $1/unit increase in input costs leads to $1/unit higher downstream prices. Pass-through appears incomplete in percentages due to a gap between prices and costs. Complete pass-through in levels contrasts with workhorse macroeconomic models that feature homothetic industry demand systems. I identify an alternative class of demand systems that yields pass-through in levels and highlight four implications. First, measuring pass-through in percentages can lead to spurious evidence of asymmetry and size dependence. Second, pass-through in levels leads to systematic fluctuations in relative price and markup dispersion that are not associated with changes in allocative efficiency. Third, pass-through in levels can explain dynamics of industry gross margins, operating profits, and entry in the data that are at odds with workhorse models. Finally, incorporating pass-through in levels into an input-output model of the U.S. economy better matches the volatility of consumer price inflation and the response of inflation to identified shocks.

How does an increase in market size, say due to globalization, affect welfare? We study this question using a model with monopolistic competition, heterogeneous markups, and fixed costs. We characterize changes in welfare and decompose changes in allocative efficiency into three different effects: (1) reallocations across firms with heterogeneous price elasticities due to intensifying competition, (2) reallocations due to the exit of marginally profitable firms, and (3) reallocations due to changes in firms’ markups. Whereas the second and third effects have ambiguous implications for welfare, the first effect, which we call the Darwinian effect, always increases welfare regardless of the shape of demand curves. We nonparametrically calibrate demand curves with data from Belgian manufacturing firms and quantify our results. We find that mild increasing returns at the microlevel can catalyze large increasing returns at the macrolevel. Between 70 and 90% of increasing returns to scale come from improvements in how a larger market allocates resources. The lion’s share of these gains are due to the Darwinian effect, which increases the aggregate markup and concentrates sales and employment in high-markup firms. This has implications for policy: an entry subsidy, which harnesses Darwinian reallocations, can improve welfare even when there is more entry than in the first best.