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Markups, Pass-Through, and Firm Heterogeneity with Sequentially Mixed Search

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  • Alex Chernoff
  • Allen Head
  • Beverly Lapham

Abstract

We study the determination of market power at the firm and industry levels when heterogeneous firms compete for sales to ex ante homogeneous buyers in a market with both directed and random search and free entry of firms that differ in productivity. Search and the distribution of productivity across active firms generate distributions of equilibrium prices and markups that we relate to variation in the elasticity of demand at the firm level. With directed search at the outset, a shock that raises the matching rate for buyers improves conditions for them and tends to lower markups. Random matching follows sequentially, and the same shock can lower the productivity threshold for operation, pushing up prices and markups for all firms. The net effect on market power can be ambiguous depending on the forces driving matching rates. The distributions of prices and markups respond in equilibrium to changes in common and firm-specific costs, consumption utility, and fixed costs of both entry and operation. We characterize the differential pass-through of these changes to prices and markups at both the firm and market levels.

Suggested Citation

  • Alex Chernoff & Allen Head & Beverly Lapham, 2025. "Markups, Pass-Through, and Firm Heterogeneity with Sequentially Mixed Search," Staff Working Papers 25-7, Bank of Canada.
    • Handle: RePEc:bca:bocawp:25-7
    DOI: 10.34989/swp-2025-7
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    References listed on IDEAS

    as
    1. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
    2. Alex Chernoff & Allen Head & Beverly Lapham, 2024. "Consumer Search, Productivity Heterogeneity, Prices, Markups, and Pass-through: Theory and Estimation," Working Paper 1523, Economics Department, Queen's University.
    3. Menzio, Guido, 2024. "Search theory of imperfect competition with decreasing returns to scale," Journal of Economic Theory, Elsevier, vol. 218(C).
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    Keywords

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    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms

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