Closed and open economy models of business cycles with marked-up and sticky prices

Shifts in the extent of competition, which affect markup ratios, are possible sources of aggregate business fluctuations. markups are countercyclical, and booms are times at which the economy operates more efficiently. We begin with a real model in which markup ratios correspond to the prices of differentiated intermediate inputs relative to the price of undifferentiated final product. If the nominal prices of the differentiated goods are relatively sticky, then unexpected inflation reduces the relative price of intermediates and, thereby, mimics the output effects from an increase in competition. In an open economy, domestic output is stimulated by reductions in the relative price of foreign intermediates and, therefore, by unexpected inflation abroad. The models tend to imply that relative output prices are more countercyclical the less competitive the sector. We find support for this hypothesis from price data of four-digit manufacturing industries.