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Heterogeneous Mark-Ups and Endogenous Misallocation

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  • Michael Peters

    (Massachusetts Institute of Technology)

Abstract

Why are resources misallocated across firms? I study an economy where misallocation stems from firms charging heterogeneous mark-ups. The distribution of mark-ups affects both aggregate TFP as well as equilibrium factor prices. While TFP is solely affected by the cross-sectional dispersion of mark-ups, factor prices depend only on the average mark-up. Mark-ups however are the result of firms' pricing decision and hence endogenous. In my model, they are determined by the process of entry and exit. If entry is more intense, aggregate TFP and factor prices are high, as product market competition reduces both the level and the dispersion of mark-ups. The static degree of misallocation is therefore closely linked to the dynamic evolution of the economy. I test the model's prediction using regional variation in the extent of entry into the manufacturing sector in Indonesia. I show that regional differences in the entry rate are negatively correlated with the average mark-up and the mark-up dispersion as the model predicts. In terms of welfare, the theory implies that the observed differences in mark-ups between high and low entry regions in Indonesia translate into TFP differences of 2.5%, differences in the steady state level of capital of 13% and differences in aggregate consumption of 6%.

Suggested Citation

  • Michael Peters, 2011. "Heterogeneous Mark-Ups and Endogenous Misallocation," 2011 Meeting Papers 78, Society for Economic Dynamics.
  • Handle: RePEc:red:sed011:78
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    File URL: https://economicdynamics.org/meetpapers/2011/paper_78.pdf
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    References listed on IDEAS

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    1. Ricardo Lagos, 2006. "A Model of TFP," Review of Economic Studies, Oxford University Press, vol. 73(4), pages 983-1007.
    2. Diego Restuccia & Richard Rogerson, 2008. "Policy Distortions and Aggregate Productivity with Heterogeneous Plants," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 707-720, October.
    3. Peter Klenow & Andrés Rodríguez-Clare, 1997. "The Neoclassical Revival in Growth Economics: Has It Gone Too Far?," NBER Chapters,in: NBER Macroeconomics Annual 1997, Volume 12, pages 73-114 National Bureau of Economic Research, Inc.
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    Cited by:

    1. Chang-Tai Hsieh & Peter J. Klenow, 2014. "The Life Cycle of Plants in India and Mexico," The Quarterly Journal of Economics, Oxford University Press, vol. 129(3), pages 1035-1084.
    2. Chris Edmond & Virgiliu Midrigan & Daniel Yi Xu, 2015. "Competition, Markups, and the Gains from International Trade," American Economic Review, American Economic Association, vol. 105(10), pages 3183-3221, October.
    3. Mary Amiti & Oleg Itskhoki & Jozef Konings, 2014. "Importers, Exporters, and Exchange Rate Disconnect," American Economic Review, American Economic Association, vol. 104(7), pages 1942-1978, July.
    4. Shenoy, Ajay, 2017. "Market failures and misallocation," Journal of Development Economics, Elsevier, vol. 128(C), pages 65-80.
    5. Zheng (Michael) Song & Guiying (Laura) Wu, 2013. "A Structural Estimation on Capital Market Distortions in Chinese Manufacturing," Economic Growth Centre Working Paper Series 1306, Nanyang Technological University, School of Social Sciences, Economic Growth Centre.
    6. Tom Schmitz, 2016. "Endogenous Growth, Firm Heterogeneity and the Long-run Impact of Financial Crises," 2016 Meeting Papers 609, Society for Economic Dynamics.

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