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Closed and Open Economy Models of Business Cycles with Marked Up and Sticky Prices

  • Robert J. Barro
  • Silvana Tenreyro

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 various versions of the model imply that the relative prices of less competitive goods move countercyclically. We find support for this hypothesis from price data of four-digit manufacturing industries.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8043.

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Date of creation: Dec 2000
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Publication status: published as The Economic Journal, Vol. 116, no. 511 (April 2006): 434-456
Handle: RePEc:nbr:nberwo:8043
Note: EFG IFM
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