Working Paper: CEPR ID: DP16796
Authors: Filip Abraham; Yannick Bormans; Jozef Konings; Werner Roeger
Abstract: This paper provides a new method to estimate price-cost margins in the presence of fixed costs of production. We exploit properties of the primal and dual revenue based and cost based Solow residual. Ignoring fixed costs in production underestimates price-cost margins and overestimates excess profit margins. Using a 30 year panel of Belgian firms we estimate price cost margins of 25.9% on average, with fixed costs as a fraction of sales of 23.4%. Fixed costs as well as price-cost margins have declined in the last three decades, pushing excess profit margins close to zero, suggesting competitive markets. The presence of fixed costs implies that price-cost margins might change not only due to a change in firms’ market power, but also due to changes in the production process (i.e., the mix between variable and fixed costs) or even due to a combination of both. Our novel methodology is able to distinguish these underlying mechanisms, thereby providing an additional layer of insight to the ongoing academic and policy debate on firms’ market power.
Keywords: price-cost margins; fixed costs; excess profits; market power
JEL Codes: D21; L13; L16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Ignoring fixed costs (G31) | Underestimates price-cost margins (D40) |
| Ignoring fixed costs (G31) | Overestimates excess profitability (D22) |
| Fixed costs (D24) | Necessary to cover price-cost margins (L11) |
| Belgian price-cost margins decline (L11) | Fixed costs ratio declines (G32) |
| Belgian price-cost margins decline (L11) | Excess profits margin declines (E25) |