Dangerous shortcuts: Ignoring marginal cost determinants in markup estimation

Abstract

De Loecker and Warzynski (2012) proposed a way to estimate markups under imperfect competition from firm-level data. The basic idea is first to estimate the elasticity of output with respect to a variable factor of production, and then divide this elasticity by the share of the input expenditure in the relevant sales. This note argues that this way to estimate markups is affected by a problem of circularity: under imperfect competition, to estimate the elasticity of an input you need to know, or estimate at the same time, the markups. The application of the proposal, ignoring this fact, is likely to produce inconsistent estimates and generate large biases in inferences about markups.