Search in the Product Market and the Real Business Cycle
Banque Centrale du Luxembourg; IRES, UCL
Thomas Y. Mathä
Central Bank of Luxembourg
March 12, 2009
ECB Working Paper No. 1036
We develop a search-matching model, where firms search for customers (e.g. in form of advertising). Firms use long-term contracts and bargain over prices, resulting in a price mark up above marginal cost, which is procyclical and depends on firms' relative bargaining power. Product market frictions decrease the steady state equilibrium, improve the cyclical properties of the model and provide a more realistic picture of firms' business environment. This suggests that product market frictions may well be crucial in explaining business cycle fluctuations. Finally, we also show that welfare costs of price rigidities are negligible relative to welfare costs of frictions.
Number of Pages in PDF File: 36
Keywords: Business cycle, Frictions, Product market, Price bargain
JEL Classification: E10, E31, E32working papers series
Date posted: March 24, 2009
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