Monopolistic competition and the cyclicality of pricing and productivity—A typology of industries

We develop a market model which explains how prices and productivity react to short-run demand variations when the number of price-setting firms is held fixed on its long-run level and profits are endogenous. We assume that for each firm the average production cost function is U-shaped, that customers are imperfectly informed about offer prices, and that customers may search for better offers.For low degrees of market transparency the long-run market outcome exhibits price dispersion with an endogenous finite number of firms. In this case, in the short run, prices and price mark-ups respond countercyclically to demand variations (while input prices are exogenously fixed) and productivity is procyclical. In the complementary case of higher degrees of market transparency, in the long run we have a single-price equilibrium. In that case, in the short run, prices are procyclical while mark-ups remain countercyclical and productivity diminishes with any deviation of demand from its long-run level.Thanks for helpful discussions go to the participants of workshops at the Winter Symposium of the Econometric Society at Warsaw 1990, at the 6th World Congress of the Econometric Society at Barcelona 1990, at the Annual Meetings of the Verein für Socialpolitik in Lugano 1991 and of its Ausschuß für Industrieökonomik in Basel 1992, and at several university workshops. Thanks go also to two anonymous referees. Financial support by the Swiss National Science Foundation, grants No 12-26387.89 and 12-28722.90, are gratefully acknowledged.