Revenue and Cost Uncertainties and Market Power

Using administrative plant-level data from India, we estimate the effect of revenue and cost uncertainties on markup (product market power), markdown (labour market power), and combined market power. We show that historical two- and three-digit industry averages of exports, imported inputs, and oil share are valid instruments for exports, imported inputs, and oil share at the plant level. The results suggest that revenue and cost uncertainties affect markup differently: revenue uncertainty decreases markup, whereas cost uncertainty increases markup. Despite the opposite effect of these uncertainty measures on product market power, revenue and cost uncertainties tend to increase combined market power. This is because the revenue uncertainty significantly increases labour market power. Heightened cost uncertainties reduce labour market power but by less compared to increases in product market power. Given the results obtained in this paper, it is important to make a distinction between revenue and cost uncertainty to understand their cyclical nature.