Understanding Markups in the Open Economy under Bertrand Competition

This paper introduces a new model to capture the key stylized facts of firm price setting behavior in the open economy. At the firm level, producers adjust their domestic prices more frequently and fully in response to marginal cost shocks than for the same goods sold abroad. At the macro level, the terms of trade are less volatile than the real exchange rate and trade liberalization reduces markups. We present tractable analytical distributions of markups that are sensitive to market structure when firms are heterogeneous, bringing trade theory up to date with existing numerical and empirical studies.