Price-Cost Margins and Shares of Fixed Factors

Posted by D. Daniel Sokol

Jozef Konings, Katholieke Universiteit Leuven and CEPR, Werner Roeger, European Commission, and Liqiu Zhao, Katholieke Universiteit Leuven explore Price-Cost Margins and Shares of Fixed Factors.

ABSTRACT: Reduced form approaches to estimate markups typically exploit variation in observed input and output. However, these approaches ignore the presence of fixed input factors, which may result in an overestimation of the price-cost margins. We first propose a new methodology to simultaneously estimate price-cost margins and the shares of fixed inputs. We then use Belgian firm level data for manufacturing and service sectors to show that markups are lower when taking into account fixed input factors. We find that the average price-cost margin of manufacturing firms is 0.041, compared to 0.090 when we do not control for fixed costs of production. We also show that price-cost margins increase with the share of fixed costs in turnover. Our findings provide new insights about observed high price-cost margins in service industries. In particular, we show that once fixed costs are taken into account, price-cost margins in service industries are comparable to those in manufacturing.