Consumer Search, Sentiments and Firm Heterogeneity

Abstract

This thesis contributes to our understanding of variations in labor productivity over the business cycle, and the long run decline in labor income share. Chapter 2 develops and analyzes a general equilibrium model with goods’ market frictions, heterogeneous firms, and consumer sentiments. I use the model to demonstrate that the interactions among these features of the model leads to new and interesting results. Firstly, average product of labor can be positively or negatively related to expected real income. Secondly, under certain conditions, lower priced firms not only sell to a larger market, but also have higher markups. Lastly, firm level pass through of firms’ idiosyncratic shocks and sentiment shocks, their elasticities of output and employment with respect to sentiment shocks can be complex. Chapter 3 constructs a stochastic general equilibrium model in which business cycles are driven by changes in sentiments to explain the Labor Productivity Puzzle. In recessions, increased search by consumers - an endogenous rise in the average number of prices observed by consumers - causes expenditures to be reallocated to the more productive firms. This effect causes employment to fall relative to output and increases APL. At the same time, less productive firms can also be insulated from a fall in demand by lower marginal labor costs during the recessions. This effect causes employment to rise relative to output and decreases APL. In calibrated versions of the model, I find that the former effect dominates over time and the theory is able to explain over three quarters of the decline in the fall in the volatility of APL and a sizable decline in the volatility of employment. Chapter 4 studies the causes of labor share decline in the retail sector. I provide microeconomic evidence that lower price retailers not only enjoy higher revenue productivities and market shares, but they also have lower labor share. Extending the framework in Chapter 2 to allow for capital accumulation, I show that the decline in labor income share can be caused by reallocation of market shares to high productivity firms as a result of technological adoptions that increase consumer search.