Abstract
This paper studies the importance of firm-level price markup dynamics for business cycle fluctuations. Using state-of-the-art IO techniques to measure the behavior of markups over the business cycle at the firm level, I find that markups are countercyclical with an average elasticity of -1.1 with respect to real GDP. Importantly, I find substantial heterogeneity in markup cyclicality across firms, with small firms having significantly more counter-cyclical markups than large firms. Then, I develop a general equilibrium model by embedding customer capital (due to deep habits as in Ravn, Schmitt-Grohe, and Uribe, 2006) into a standard Hopenhayn (1992) model of firm dynamics with entry and exit. The calibrated model replicates these empirical facts and produces counter-cyclical firm sales dispersions consistent with the data. The resulting input misallocation amplifies both the volatility and persistence of the aggregate productivity shocks driving the business cycle.
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