Income Dispersion and Counter-Cyclical Markups

Abstract

We construct a model of counter-cyclical markups based on cyclical variation in the dispersion of income across agents. The model is neoclassical in most respects, with monopolistically competitive firms facing a distribution of buyers that changes through time. Income dispersion is high during recessions, which reduces the price elasticity of demand and increases markups applied by firms. Using recent estimates of counter-cyclical income dispersion, we calibrate the model and show that it generates realistic markups as well as other salient features of business cycles.