How Costly Are Markups?

Chris Edmond, Virgiliu Midrigan, Daniel Yi Xu

NBER Working Paper No. 24800
Issued in July 2018
NBER Program(s):Economic Fluctuations and Growth, Industrial Organization, Monetary Economics, Productivity, Innovation, and Entrepreneurship

We study the welfare costs of markups in a dynamic model with heterogeneous firms and endogenously variable markups. We find that the welfare costs of markups are large. We decompose the costs of markups into three channels: (i) an aggregate markup that acts like a uniform output tax, (ii) misallocation of factors of production, and (iii) an inefficiently low rate of entry. We find that the aggregate markup accounts for about two-thirds of the costs, misallocation accounts for about one-third, and the costs due to inefficient entry are negligible. We evaluate simple policies aimed at reducing the costs of markups. Subsidizing entry is not an effective tool in our model: while more competition reduces individual firms' markups it also reallocates market shares towards larger firms and the net effect is that the aggregate markup hardly changes. Size-dependent policies aimed at reducing concentration can reduce the aggregate markup but have the side effect of greatly increasing misallocation and reducing aggregate productivity.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w24800