Markups, Gaps, and the Welfare Costs of Business Fluctuations

UPF Economics and Business Working Paper 836

46 Pages Posted: 29 Nov 2005

See all articles by Jordi Galí

Jordi Galí

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Massachusetts Institute of Technology (MIT) - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Mark Gertler

New York University - Leonard N. Stern School of Business - Department of Economics; National Bureau of Economic Research (NBER)

David Lopez-Salido

Board of Governors of the Federal Reserve System

Multiple version iconThere are 4 versions of this paper

Date Written: May 2005

Abstract

In this paper we present a simple theory-based measure of the variations in aggregate economic efficiency: the gap between the marginal product of labor and the household's consumption/leisure tradeoff. We show that this indicator corresponds to the inverse of the markup of price over social marginal cost, and give some evidence in support of this interpretation. We then show, that, with some auxilliary assumptions our gap variable may be used to measure the efficiency costs of business fluctuations. We find that the latter costs are modest on average. However, to the extent the flexible price equilibrium is distorted, the gross efficiency losses from recessions and gains from booms may be large. Indeed, we find that the major recessions involved large efficiency losses. These results hold for reasonable parameterizations of the Frisch elasticity of labor supply, the coefficient of relative risk aversion, and steady state distortions.

Keywords: Business cycles, countercyclical markups, welfare costs

JEL Classification: E32

Suggested Citation

Gali, Jordi and Gertler, Mark and Lopez-Salido, David, Markups, Gaps, and the Welfare Costs of Business Fluctuations (May 2005). Available at SSRN: https://ssrn.com/abstract=859566 or http://dx.doi.org/10.2139/ssrn.859566

Jordi Gali (Contact Author)

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain
+34 93 542 2754 (Phone)
+34 93 542 1746 (Fax)

HOME PAGE: http://www.econ.upf.es/~gali

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
Cambridge, MA 02142
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Mark Gertler

New York University - Leonard N. Stern School of Business - Department of Economics ( email )

269 Mercer Street
7th Floor
New York, NY 10003
United States
212-998-8931 (Phone)
212-995-4186 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

David Lopez-Salido

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
47
Abstract Views
630
PlumX Metrics