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Markup Cyclicality: A Tale of Two Models

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  • Sungki Hong

Abstract

Many models in the business cycle literature generate counter-cyclical price markups. This paper examines if the prominent models in the literature are consistent with the empirical findings of micro-level markup behavior in Hong (2016). In particular, I test the markup behavior of the following two models: (i) an oligopolistic competition model, and (ii) a New Keynesian model with heterogeneous price stickiness. First, I explore the Atkeson and Burstein (2008) model of oligopolistic competition, in which markups are an increasing function of firm market shares. Coupled with an exogenous uncertainty shock as in Bloom (2009), i.e. a second-moment shock to firm productivities in recessions, this model results in a countercyclical average markup, as in the data. However, in contrast with the data, this model predicts that smaller firms reduce their markups. Second, I calibrate both Calvo and menu cost models of price stickiness to match the empirical heterogeneity in price durations across small and large firms, as in Goldberg and Hellerstein (2011). I find that both models can match the average counter-cyclicality of markups in response to monetary shocks. Furthermore, since small firms adjust prices less frequently, they exhibit greater markup counter-cyclicality, consistent with the empirical patterns. Quantitatively, however, only the menu cost model, through its selection effect, can match the extent of the empirical heterogeneity in markup cyclicality. In addition, both sticky price models imply pro-cyclical markup behavior in response to productivity shocks.

Suggested Citation

  • Sungki Hong, 2017. "Markup Cyclicality: A Tale of Two Models," Working Papers 2017-34, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2017-034
    DOI: 10.20955/wp.2017.034
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    References listed on IDEAS

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    1. Virgiliu Midrigan, 2011. "Menu Costs, Multiproduct Firms, and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 79(4), pages 1139-1180, July.
    2. Andrew Atkeson & Ariel Burstein, 2008. "Pricing-to-Market, Trade Costs, and International Relative Prices," American Economic Review, American Economic Association, vol. 98(5), pages 1998-2031, December.
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