Markups: A Search-Theoretic Perspective

Across macroeconomics, market power is almost always modelled with the Dixit–Stiglitz (1977) monopolistic-competition framework, in which a seller’s markup is pinned down by how substitutable buyers perceive its variety to be. This paper instead derives a closed-form formula for the equilibrium distribution of markups in the search-theoretic model of imperfect competition of Butters (1977), Varian (1980) and Burdett–Judd (1983), where a seller has market power not because its good lacks substitutes but because search and information frictions leave some buyers unable to reach the cheapest seller. In this model markups are strictly positive even though all sellers’ varieties are perfect substitutes, are dispersed even when all sellers operate the same technology, and — once sellers differ in marginal cost — can be increasing, decreasing, or constant in a seller’s size; yet the equilibrium is efficient. Menzio proves an “anything-goes” result: any twice-differentiable markup function can arise as an equilibrium for an appropriate choice of parameters, so a Dixit–Stiglitz model can always reproduce the search model’s markups — but only with reduced-form buyer preferences that depend on the search model’s deep parameters and are therefore unstable to policy changes (a Lucas-critique problem), and that would (incorrectly) read those markups as symptoms of inefficiency and a case for corrective subsidies. The paper’s central and deliberately modest claim is a cautionary one for macroeconomics: because two well-established models can both match observed markups yet imply opposite conclusions about welfare, optimal policy, and counterfactuals, markup data alone cannot identify the macroeconomic consequences of market power — one also needs evidence on the origin of that market power. The results are theoretical (unit demand, constant returns to scale, a Poisson contact process); the sharp comparative statics are derived for a log-uniform cost distribution, and the same logic extends to labor-market markdowns in the Burdett–Mortensen (1998) model.

Guido Menzio | Macro Paper Warehouse

Markups: A Search-Theoretic Perspective