Imperfect Competition and the Dynamics of Mark-Ups

Abstract

This paper investigates the behaviour of the mark-up of prices over marginal costs under two different assumptions about market structure. In the customer market model firms lower their mark-up when current output is low relative to future profits, foregoing current profits in order to capture future market share. In markets characterised by implicit collusion, firms lower their mark-ups when current output is high relative to future profits in order to lower the incentives to undercut the implicit cartel. Only the customer market model generates predictions consistent with UK evidence, but this in inconsistent with evidence from the United States. It may be necessary to use more than one model to explain all the facts.

JEL Classification: E39, L11