International real business cycles with endogenous markup variability

• Published in: Journal of international economics 2011-11, Vol.85 (2), p.302-316
• Main Authors: Davis, J. Scott, Huang, Kevin X.D.
• Format: Article
• Language: English
• Subjects: Balance of trade; Business cycles; Economic activity; Economic conditions; Economic forecasts; Economic indicators; Economic models; Endogenous markup variability; Endogenous markup variability International Business cycle Co-movement International real business cycles; Game theory; GDP; Gross Domestic Product; International Business cycle Co-movement; International economics; International real business cycles; Macroeconomics; Output rate; Pricing policies; Production level; Studies
• ISSN: 0022-1996; 1873-0353
• DOI: 10.1016/j.jinteco.2011.06.004

The aggregate impact of decisions made at the level of the individual firm has recently attracted a lot of attention in both the macro and trade literatures. We adapt the benchmark international real business cycle model to a game-theoretic environment to add a channel for the strategic interaction among domestic and foreign firms. We show how the sum of strategic pricing decisions made at the level of the individual firm can have significant effects on the volatility and cross country co-movement of GDP and its components. Specifically we show that the addition of this one channel for strategic interaction leads to a significant increase in the cross-country co-movement of production and investment, as well as a significant decrease in the volatility of investment and the trade balance over the benchmark IRBC model. ► We examine the macroeconomic effects of firm level strategic decisions. ► The firm's pricing power, and thus its optimal markup increases in its market share. ► We incorporate endogenous markup variability in an IRBC model. ► This mitigates the price divergence following a country specific productivity shock. ► This leads to a significant increase in cross-county business cycle co-movement.