Markups and competition in Canada

Markups, the ratio of price over marginal costs, increased from 2001 to 2019, according to a new paper, "Estimating Markups Using Firm-Level Data: A Comparative Analysis," released today.

Estimating markups is important because an increase in markups is associated with lower consumer welfare and increased inefficiency in an economy. Moreover, rising markups indicate a decline in competitive intensity when, at the same time, the entry of new firms declines, and the profits of active firms increase.

This study applies the "production function" approach to estimate markups using accounting data at the firm level. These estimates depend highly on how variable costs are measured. The paper uses wages, operating expenses, and the cost of goods sold as the measures of variable costs to estimate markups. It found that, from 2001 to 2019, markups increased by 5.3% when wages were used to measure variable costs, and by 13.3% when the cost of goods sold was used to measure variable costs.

For example, a 5.3% increase in markups means that if the ratio of price over the marginal cost (the incremental cost of producing the final unit) of products for a firm was 100 in 2001, it increased to 105.3 in 2019.

The study also found a significant divergence in the distribution of markups across firms. The increase in average markups was mainly driven by markups of firms at the upper percentiles of the distribution.

Finally, the paper finds that firm entry rates declined and average profitability increased from 2001 to 2019. Along with the increase in markups, the evidence presented in this paper indicates a decline in competitive intensity among Canadian industries in the period from 2001 to 2019.

Chart 1: Estimating markups using different measures of variable costs

Note: COGS = cost of goods sold and OpEx = operating expenses.

Sources: Author's calculations using the National Accounts Longitudinal Microdata File.