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Do Price Markups Differ by Firm Size Over the Business Cycle?


Thursday, September 13, 2018

price markups
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Price markups among firms exhibit countercyclical behavior—that is, markups tend to decline when aggregate output rises, and vice versa. Furthermore, markups of small firms appear to be more sensitive to the business cycle than those of large firms, according to a recent Economic Synopses essay.

Why Look at Price Markup

Economist Sungki Hong noted that understanding the dynamics of firm market power is an important macroeconomic issue. He explained that one measure of market power is the price markup, which is a ratio of price over the marginal cost of production. A relatively high price markup implies that the firm has high market power.

“Numerous studies … have found that variations in markup account for much of the fluctuations in aggregate output and employment over business cycles,” Hong wrote. “Also, markup cyclicality has important implications for inflation dynamics.”

Markups of Small vs. Large Firms

To estimate markup behaviors, Hong used firm-level data in manufacturing sectors of France. He used the Bureau van Dijk Amadeus dataset. The measure of firm-level markup that he used was proportional to the inverse of the material cost share of revenue (that is, revenue divided by material cost).

He estimated markup cyclicality for all firms as well as for small firms and large firms.Large firms were defined as those with more than 1 percent market share within their industries. Those firms that didn’t meet this definition were classified as small firms. “Markups of small and large firms have the potential to move differently for several reasons, including firm-brand reputation and pricing adjustment frictions,” he noted.

Hong found that price markups are indeed countercyclical. In particular, he found that:

  • For all firms, the markup elasticity was –1.1 (that is, a 1 percent increase in real gross domestic product from trend caused a 1.1 percent decline in the markup). 
  • For large firms, the markup elasticity was –0.76.
  • For small firms, the markup elasticity was –1.21.

These results imply that price markups of small firms fluctuate 45 percent more than those of large firms along the business cycle, Hong noted.

“With the micro-level data, I confirm the old finding that markups are countercyclical but also find that markups of small firms are relatively more cyclical,” he wrote.

Notes and References

1 He used the Bureau van Dijk Amadeus dataset.

2 Large firms were defined as those with more than 1 percent market share within their industries. Those firms that didn’t meet this definition were classified as small firms.

Additional Resources

Posted In Inflation  |  Tagged sungki hongbusiness cycleinflation