Endogenous Market Structure and the Business Cycle

We introduce endogenous strategic interactions under competition in quantities and in prices together with endogenous entry in a dynamic stochastic general equilibrium model with flexible prices. The endogenous mark ups depend on the form of competition and on the degree of substitutability between goods, and they vary countercylically while profits are procyclical. Positive temporary shocks to productivity and government spending attract entry. Entry strengthens competition between firms, which temporary reduces mark ups and prices: this creates an intertemporal substitution effect which provides an extra boost to consumption. The model outperforms the standard RBC framework in matching impulse response functions and second moments for US data.