A Note on Industry Dynamics and Countercyclical Markups

Abstract

In order to explain countercyclical markups, a simple two-period model of industry

dynamics is constructed where output is produced potentially by two firms which are

subject to idiosyncratic productivity shocks as well as aggregate productivity shocks.

During booms, both firms with low and high productivity stay in the market and engage in

a Bertrand-type competition to yield marginal-cost pricing, implying zero markups. During

recessions, however, firm with low productivity shock decides to exit, allowing the highproductivity

firm to enjoy positive markups as a monopolist in the output market.