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Mark-ups, Gaps and the Welfare Costs of Business Fluctuations

  • Galí, Jordi
  • Gertler, Mark
  • Lopez-Salido, Jose David

In this Paper we present a simple, theory-based measure of the variations in aggregate economic efficiency that is based on the difference between the marginal product of labour and the household’s consumption/leisure trade-off. We show that this indicator corresponds to the inverse of the mark-up of price over social marginal cost and give some evidence in support of this interpretation. We then show that this indicator may be used to measure the efficiency costs of business fluctuations. We find that the efficiency costs of fluctuations are modest on average. The major recessions involve significant welfare losses, however, even after netting out the gains from the preceding boom. These results hold for reasonable parameterizations of both the Frisch elasticity of labour supply and the coefficient of relative risk aversion.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4134.

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Date of creation: Dec 2003
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Handle: RePEc:cpr:ceprdp:4134
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