The Relation between Price and Marginal Cost in U.S. Industry: A Contradiction

In a recent article in this Journal, Hall (1988) examined productivity shocks at the industry level, derived from constant returns to scale production functions in which firms were assumed to be competitive. Hall had two important conclusions. First, he showed that productivity shocks (i.e., Solow residuals) were correlated with aggregate demand variables, implying that the former are not exogenous impulses. Second, his results implied that firms persistently charge prices above marginal costs, making inappropriate the constant returns to scale competitive production function, assumed in many theoretical frameworks. Because of the importance of Hall's findings, the article has led to many extensions. Evans (1992) confirms the empirical finding of significant correlations between productivity shocks and aggregate demand variables; Burnside, Eichenbaum, and Rebelo (1993) show that this correlation can be explained by introducing labor hoarding into a theoretical model with competitive firms and constant returns to scale production functions. The markups above marginal cost are explained by Eden and Griliches (1991) and Galeotti and Schiantarelli (1991) by modifying the theoretical production function. Caballero and Lyons (1992), using the Hall data and methodology, examine the possibility of external economies in the aggregate manufacturing production. Finally, Waldmann (199 1) argues in this Journal that the