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Working Papers, No. 2024-13, May 2024 Crossref
Investment-Goods Market Power and Capital Accumulation

We develop a model of capital accumulation in an open economy that imports investment goods from large foreign firms with market power. We model investment-goods producers as a dynamic oligopoly and characterize a Markov Perfect Equilibrium with a Generalized Euler Equation. We use this optimality condition to analyze the joint evolution of investment, prices, and markups. The markup on investment goods decreases as the economy accumulates capital toward its steady state, generating a state-dependent capital adjustment cost. We analyze the role of commitment to future production of investment goods for the dynamics of markups and investment. We use a calibrated version of the model to simulate the effects of shocks to the demand for durable goods and semiconductors during the post-2020 world recovery. Finally, we perform counterfactual analyses on the effects of expanding the production capacity. The model highlights the separate roles of increasing marginal costs—akin to capacity constraints—and market power.

Working papers are not edited, and all opinions and errors are the responsibility of the author(s). The views expressed do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System.

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