Markups and Demand Shocks: Using Microdata from Single-Product Firms to Disentangle Unobservables

Abstract:

The cyclical behavior of markups has been at the center of macroeconomic debate on the origins of business-cycle fluctuations and policy effectiveness. In theory, markups may fluctuate endogenously with the business cycle due to sluggish price adjustment or to deeper motives affecting the price-elasticity of demand faced by individual producers. In this article we make use of a large firm- and product-level panel of Portuguese manufacturing firms in the 2004-2010 period. Perhaps the biggest empirical challenge is to obtain a measure of TFP that is purged from demand shocks. One important advantage of this dataset is that we obtain product-level prices at a yearly frequency allowing us to separately estimate both supply and demand. Our main results suggest that markups are pro-cyclical conditional on TFP shocks and generally counter-cyclical with demand shocks. Leverage magnify the demand shocks which suggests that leveraged firms have steeper cost curves.