RDP 2025-05: How Costly are Mark-ups in Australia? The Effect of Declining Competition on Misallocation and Productivity 7. Broader Cost of Mark-ups
August 2025
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So far we have focused on the negative impact that mark-ups, and in particular dispersion in markups, has on productivity via misallocation of resources across firms. But, as discussed above, this is only one channel through which rising mark-ups could have economic costs. We now turn to the broader economic costs.
To consider these costs, we solve the full EMX model with the mark-up distortions and without them (often referred to as the social planner problem). This will capture the three different channels through which mark-ups and market power will affect the economy: the traditional deadweight loss channel; the inefficient entry channel; and the misallocation channel. It will also capture the full dynamic costs, instead of just the ‘static’ allocation costs noted above.
Table 11 shows the results, again focusing on the baseline model. The columns show the gains that could be achieved by eliminating mark-ups and returning to the first-best allocation in the economy, in terms of output, consumption, labour inputs and total consumer welfare. In all cases we compare the steady states to the first-best, and ignore any transition dynamics in moving from one to the other.
| Output | Consumption | Hours | Welfare | |
|---|---|---|---|---|
| Harmonic sales-weighed mark-up measures | ||||
| Mid-2000s, relative to first-best | 82 | 61 | 23 | 35 |
| Mid-2010s, relative to first-best | 141 | 106 | 31 | 61 |
| Mid-2000s, relative to mid-2010s | 32 | 28 | 7 | 20 |
| Cost-weighed mark-up measures | ||||
| Mid-2000s, relative to first-best | 144 | 108 | 31 | 63 |
| Mid-2010s, relative to first-best | 247 | 187 | 41 | 108 |
| Mid-2000s, relative to mid-2010s | 42 | 38 | 7 | 28 |
| Note: Shows percentage total gain from moving from one equilibrium to another (i.e. ignoring transition dynamics). | ||||
We can see that, relative to the first-best, mark-ups create large economic costs. These costs are on a similar scale to those documented in EMX. Removing all mark-ups in the mid-2000s would have raised GDP by 82 per cent, and household welfare by 35 per cent (for the harmonic sales-weighted version).
That said, this is not a particularly feasible and useful benchmark.[15] A more interesting comparison is to compare outcomes between the mid-2000s and mid-2010s. The results suggest that output and consumption would have been around 30–40 per cent higher if the economy was in the more competitive mid-2000s state, compared to the less competitive mid-2010s state. Household welfare would have been around 20–30 per cent higher. These losses are an order of magnitude larger than those noted earlier.
These larger costs reflect two factors. First, we are capturing the additional channels through which mark-ups can affect economic outcomes. As shown in Table B9, incorporating the deadweight loss channel accounts for a large share of the additional costs, and removing this distortion (via a uniform subsidy for production) removes much of the cost of mark-ups in the model. Second, these calculations account for the dynamic effects that, for example, lower productivity has on choices around the capital stock and firm entry, and therefore the overall size of the economy.
That said, it is important to keep in mind that these broader costs are more reliant on a larger set of modelling assumptions and parameters, compared to the misallocation costs. Moreover, they are more reliant on having an accurately estimated level of mark-ups. Some papers have argued that mark-ups estimated using production function approaches, such as those in Hambur (2023), can have difficulty accurately identifying the level of mark-ups (e.g. Bond et al 2021). Focusing on changes in the level of mark-ups over time can limit these issues, as the change in the mark-up may be well identified even if the level is not. However, EMX show that the full welfare costs of mark-ups increase nonlinearly as mark-ups rise in their model. So the starting level of mark-ups still matters for these welfare calculations.
All this is to say that these results suggest that the costs of declining competition are potentially significantly larger than those identified through the productivity misallocation channel we have focused on for most of the paper. But it is harder to create precise estimates of these costs. Even focusing on the two different ways of aggregating firm-level mark-ups, we get welfare gains ranging from 20 to 28 per cent.
Footnote
Assessing against a no mark-up benchmark is also difficult, given some amount of mark-ups might be needed to recoup fixed costs, or incentivise innovation. [15]