Entry cost, fixed cost and markup: Theory and evidence from the impact of corruption on prices

Abstract

The welfare costs of markups are large. We analyze the impact of firm’s entry cost, fixed cost, and variable cost on markups using a general equilibrium model. The results show that entry cost induces higher markups, whereas fixed cost reduces markups with a stronger effect in low-income countries and for high-quality goods. As an empirical application, we examine the impact of corruption on the prices of identical products across countries. We find that the prices and markups are higher in more corrupt countries, and the effect is stronger in low-income countries and for high-quality products. These results suggest that corruption causes higher entry costs and fixed costs, leading to a fewer number of firms and more misallocations among firms in equilibrium. Therefore, the model is useful for distinguishing entry and fixed costs empirically, and it highlights the importance of identifying the nature of the cost to better understand their impact on markups and welfare.