Price-Cost Margins and Fixed Costs

59 Pages Posted: 4 Feb 2022

See all articles by Filip Abraham

Filip Abraham

KU Leuven; Vlerick Business School

Yannick Bormans

KU Leuven

Jozef Konings

University of Liverpool

Werner Roeger

German Institute for Economic Research (DIW Berlin)

Date Written: December 1, 2021

Abstract

This paper provides a new method to estimate price-cost margins in the presence of fixed costs of production. We exploit properties of the primal and dual revenue based and cost based Solow residual. Ignoring fixed costs in production underestimates price-cost margins and overestimates excess profit margins. Using a 30 year panel of Belgian firms we estimate price cost margins of 25.9% on average, with fixed costs as a fraction of sales of 23.4%. Fixed costs as well as price-cost margins have declined in the last three decades, pushing excess profit margins close to zero, suggesting competitive markets. The presence of fixed costs implies that price-cost margins might change not only due to a change in firms' market power, but also due to changes in the production process (i.e., the mix between variable and fixed costs) or even due to a combination of both. Our novel methodology is able to distinguish these underlying mechanisms, thereby providing an additional layer of insight to the ongoing academic and policy debate on firms' market power.

Keywords: excess profits, Fixed Costs, market power, Price-cost margins

Suggested Citation

Abraham, Filip and Bormans, Yannick and Konings, Jozef and Roeger, Werner, Price-Cost Margins and Fixed Costs (December 1, 2021). CEPR Discussion Paper No. DP16796, Available at SSRN: https://ssrn.com/abstract=4026661

Filip Abraham (Contact Author)

KU Leuven ( email )

Oude Markt 13
Leuven, Vlaams-Brabant 3000
Belgium

Vlerick Business School

Library
REEP 1
Gent, BE-9000
Belgium

Yannick Bormans

KU Leuven ( email )

Oude Markt 13
Leuven, Vlaams-Brabant 3000
Belgium

Jozef Konings

University of Liverpool ( email )

Chatham Street
Brownlow Hill
Liverpool, L69 7ZA
United Kingdom

Werner Roeger

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstra├če 58
Berlin, 10117
Germany

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