Exchange Rate Shocks and Quality Adjustments

Do firms respond to cost shocks by reducing the quality of their products? Using microdata from a large Russian retailer that refreshes its product line twice-yearly, we document that higher quality products are more profitable than lower quality ones, but that the number of high-quality products experiences a relative decrease after a large ruble devaluation in 2014. We show that rising firm costs-and not shrinking consumer incomes-explains the reallocation, and rationalize the data with a model that features consumer expenditure switching between high and low qualities. The reallocation to lower quality products reduces average pass-through by 26%.