Markups, gaps, and the welfare costs of business fluctuations

Jordi Galí, Mark Gertler, J. David López-Salido

    Research output: Contribution to journalArticlepeer-review

    Abstract

    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 reciprocal of the markup of price over social marginal cost, and give some evidence in support of this interpretation. We then show that, with some auxiliary 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 that 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 parameterization s of the Frisch elasticity of labor supply, the relative risk aversion, and steady-state distortions.

    Original languageEnglish (US)
    Pages (from-to)44-59
    Number of pages16
    JournalReview of Economics and Statistics
    Volume89
    Issue number1
    DOIs
    StatePublished - Feb 2007

    ASJC Scopus subject areas

    • Social Sciences (miscellaneous)
    • Economics and Econometrics

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