Working paper No. 72
By Ian Small
This paper looks at price cost mark-ups and firm profit margins in UK manufacturing and services. In particular it examines how they behave over the business cycle. It has two main findings. First, the estimated average mark-ups and the profit margin results both suggest that there is imperfect competition in manufacturing and services. Second, mark-ups are pro-cyclical, as are profit margins even after allowing for movements in their standard determinants. This suggests that price pressures may increase during recovery periods and decrease during recessions. One possible explanation for this is Kreps and Scheinkman’s argument that the pro-cyclicality of capacity constraints means that firms move between Cournot and Bertrand competition over the cycle. The finding that mark-ups are pro-cyclical also raises doubts about macroeconomic models that assume that demand shocks may affect employment via counter-cyclical mark-ups.