Macroeconomics with Endogenous Markups and Optimal Taxation

Abstract

The neoclassical macroeconomic framework is extended to general preferences over a variety of goods supplied under monopolistic, Bertrand or Cournot competition to derive implications for business cycle, market inefficiencies and optimal corrective taxation. When markups are endogenously countercyclical the impact of shocks on consumption and labor supply is magnified through new intertemporal substitution mechanisms, and the optimal fiscal policy requires a countercyclical labor income subsidy and a capital income tax that is positive along the growth path and converging to zero in the long run. With an endogenous number of goods and strategic interactions, entry affects markups and the optimal fiscal policy requires also a tax on profits. We characterize the equilibrium dynamics and derive explicit tax rules for a variety of intratemporal preference aggregators including the quadratic, directly additive, indirectly additive and homothetic classes.