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Market Structure and Monetary Non-Neutrality

Simon Mongey

No 184, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: Canonical macroeconomic models of pricing under nominal rigidities assume markets consist of atomistic firms. Most US retail markets are dominated by a few large firms. To bridge this gap, I extend an equilibrium menu cost model to allow for a continuum of sectors with two large firms in each sector. Compared to a model with monopolistically competitive markets, and calibrated to the same good-level data on price adjustment, the duopoly model generates output responses to monetary shocks that are more than twice as large. Firm-level prices respond equally to idiosyncratic shocks, but less to aggregate shocks in the calibrated duopoly model. Under duopoly, the response of low priced firms to an increase in money is dampened: a falling real price at its competitor weakens both the incentive to increase prices, and price conditional on adjustment. The dynamic duopoly model also implies (i) large first order welfare losses from nominal rigidities, (ii) lower menu costs, (iii) a U-shaped relationship between market concentration and price flexibility, forwhich I find strong evidence in the data, (iv) a source of downward bias in markup estimates attained from inverting a static oligopoly model.

New Economics Papers: this item is included in nep-com, nep-dge, nep-mac and nep-mon
Date: 2017
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