The Effects of Local Demand and Supply Restrictions on Markup
73 Pages Posted: 6 Jul 2022
Date Written: June 22, 2022
Markup fluctuations are often the combined outcome of sources of variability with conflicting effects. We exploit a natural experiment framework based on episodes of unanticipated cuts in city council spending and of firm exits from the market to investigate the markup response to contractions in demand and supply. A temporary contraction in demand leads to a sharp reduction in the markups of differentiated goods, transport and business services, whereas it drives down labour costs in the retail, wholesale and accommodation sectors, without affecting markups. A persistent contraction in supply leads to a boost in markups, the magnitude of which is heterogeneous among firms, as those with the lowest markups tend to display the largest increases, while those with the highest markup mainly benefit in terms of new market shares. For retail and wholesale trade and for accommodation, the contraction in supply has a lasting effect. Province-level results taking into account spillovers across sectors and municipalities bring out the co-movement of markup and revenue. Overall, our findings point to labour market adjustments and the substitutability of workers to explain markup variability and suggest an increased sales-weighted aggregate markup following a recession.
Keywords: demand/supply contraction, markup, local competition, labor market, demand reallocation
JEL Classification: E30, D22, D40
Suggested Citation: Suggested Citation