Working Paper: NBER ID: w3534
Authors: Julio J. Rotemberg; Michael Woodford
Abstract: If changes in aggregate demand were an important source of macroeconomic fluctuations, real wages would be countercyclical unless markups of price over marginal cost were themselves countercyclical. We thus examine three theories of markup variation at cyclical frequencies. The first assumes only that the elasticity of demand is a function of the level of output. In the second, firma face a tradeoff between exploiting their existing customers and attracting new customers. Markups then depend also on rates of return and future sales expectations; a high rate of return or expectations of low sales growth lead firms to assign a lower value to future revenues from new customers. Firma thus raise prices and markups. In the third theory, markups are chosen to ensure that no one deviates from an (implicitly) collusive understanding. Increases in rates of return or pessimistic expectations then lead firms to be less concerned with future punishments so that markups fall. Aggregate post-war data from the U.S. are moat consistent with the predictions of the implicit collusion model.
Keywords: markup variation; aggregate demand; real wages; macro fluctuations
JEL Codes: E32; D43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| aggregate demand changes (E00) | real wages (J31) |
| markup variations (Y60) | economic fluctuations (E32) |
| output increases (E23) | elasticity of demand changes (D12) |
| elasticity of demand changes (D12) | markup variations (Y60) |
| higher future sales expectations (D84) | higher markups (D49) |
| increases in rates of return (G19) | markup levels (D43) |
| low discount rate of future cash flows (E43) | high prices as investment (G19) |