The Cyclical Behavior of Prices and Costs

117 Pages Posted: 17 Jun 1999 Last revised: 16 May 2000

See all articles by Julio J. Rotemberg

Julio J. Rotemberg

Harvard University, Business, Government and the International Economy Unit (deceased); National Bureau of Economic Research (NBER) (deceased)

Michael Woodford

Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)

Date Written: January 1999

Abstract

Because inputs are scarce, marginal cost should be an increasing function of output. Without changes in this real marginal cost schedule, aggregate output can vary if and only if the markup of price over marginal cost varies. In this review, we discuss the extent to which observed fluctuations in aggregate economic activity depend upon such variations in average markups. We first study whether, empirically, real marginal cost rises in cyclical expansions. Average real labor cost is not very procyclical, but, for reasons such as overhead labor and adjustment costs, marginal labor cost should be more procyclical. Measures of marginal cost based on materials costs and inventories also appear procyclical. We next show that countercyclical markup variation may, depending upon how costs are modeled, account for a substantial fraction of cyclical output movements. We also show that the observed procyclical variations in productivity and profits are consistent with the hypothesis that cyclical variations in output are primarily due to markup variations than to shifts in the real marginal cost schedule. Finally, we survey theories of endogenous markup variation. These include both models of sticky and models in which firms' desired markup varies over time.

Suggested Citation

Rotemberg, Julio J. and Woodford, Michael, The Cyclical Behavior of Prices and Costs (January 1999). NBER Working Paper No. w6909. Available at SSRN: https://ssrn.com/abstract=147708

Julio J. Rotemberg (Contact Author)

Harvard University, Business, Government and the International Economy Unit (deceased) ( email )

Cambridge, MA
United States
617-495-1015 (Phone)
617-496-5994 (Fax)

National Bureau of Economic Research (NBER) (deceased)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Michael Woodford

Columbia University, Graduate School of Arts and Sciences, Department of Economics ( email )

420 W. 118th Street
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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