The Cyclical Behavior of the Price-Cost Markup

Abstract

Countercyclical markups constitute the key transmission mechanism for monetary and other “demand” shocks in textbook New Keynesian models. This paper tests the foundation of those models by studying the cyclical properties of the markup of price over marginal cost. The first part of the paper studies markups in the aggregate economy and the manufacturing sector. We use Bils’s (1987) insights for converting average cost to marginal cost, but do so with richer data. We find that all measures of markups are either procyclical or acyclical. Moreover, we show that monetary shocks lead markups to fall with output. The last part of the paper merges input-output information on shipments to the government with detailed industry data to study the effect of demand changes on industry-level markups. Industry-level markups are found to be acyclical in response to demand changes.

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