FIRM DYNAMICS, ENDOGENOUS MARKUPS, AND THE LABOR SHARE OF INCOME

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Abstract
Recent U.S. evidence suggests that the response of labor share to a productivity shock is characterized by countercyclicality and overshooting. These findings cannot be reconciled easily with existing business cycle models. We extend the Diamond–Mortensen–Pissarides model of search in the labor market by considering strategic interactions among an endogenous number of producers, which leads to countercyclical price markups. Although Nash bargaining delivers a countercyclical labor share, we show that countercyclical markups are fundamental to address the overshooting. On the contrary, we find that real wage rigidity does not seem to play a crucial role in the dynamics of the labor share of income.

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