Endogenous Market Structures and the Business Cycle June 17, 2009

Andrea Colciago (University of Milano, Bicocca)

Abstract
We characterize endogenous market structures under competition in prices and quantities with endogenous entry in a DSGE model. Short run markups vary countercyclically because of the impact of entry on competition. Long run mark ups are decreasing in the discount factor and in productivity, and increasing in the exit rate and in the entry costs. Dynamic inefficiency can emerge due to excessive entry under competition in quantities. Positive temporary shocks to productivity and government spending attract entry, which strengthens competition so as to temporary reduce the prices: this competition effect creates an intertemporal substitution effect which provides an extra boost to consumption. The interplay between the dynamics of the number of firms, sunk entry costs and strategic interactions among producers improves the ability of a flexible prices model in matching impulse response functions and second moments for U.S. data.

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