School of Economics

2018 Discussion papers

School of Economics Discussion Paper 18/12

Measured Productivity with Endogenous
Markups and Economic Profits

Anthony Savagar, University of Kent

October 2018


I develop a model of dynamic firm entry, oligopolistic competition and returns to scale in order to decompose TFP fluctuations into technical change, economic profit and markup fluctuations. I show that economic profits cause short-run upward bias in measured TFP, but this subsides to upward bias from endogenous markups as firm entry adjusts. I analyze dynamics analytically through a nonparametric DGE model that allows for a perfect competition equilibrium such that there are no biases in measured TFP. Given market power, simulations show that measured TFP is 40% higher than technology in the short-run, due solely to profits, and 20% higher in the long-run due solely to markups. During transition both effects contribute upward bias: initially the profit effect dominates, but by 5 quarters the two effects contribute equally, and by 10 quarters only the markup effect persists. The speed of firm adjustment (‘business dynamism’) will determine these timings and therefore the importance of each bias.

JEL Classification: E32; D21; D43; L13; C62

Keywords: Endogenous Markups, Dynamic Firm Entry, Endogenous Productivity, Endogenous Entry Costs

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Last Updated: 08/11/2018