Capacity utilization and market power

In a monopolistic competition framework, we propose a dynamic model in which capacity underutilization is a macroeconomic equilibrium feature relying on a diversity of microeconomic situations. Capacity underutilization follows from microeconomic uncertainty at the time firms must decide on their productive capacity. We settle a relationship between capacity utilization and markups via the effect of capacity utilization rate changes on firms' market power. We show that such a relationship influences significantly the short run response of the economy to exogenous shocks. In particular, the same shock can have quite different short run effects depending on the characteristics of the initial stationary state (low or high capacity utilization rate).