Heterogeneous Firms and the Phillips Curve

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This paper provides building micro-level blocks necessary to model an aggregate New Keynesian Phillips Curve in an economy where firms are heterogeneous in their production technology and the demand curves they face. The research utilizes prices and quantities of outputs and factor inputs of manufacturing firms along with exogenous downstream demand instruments from global input-output and trade data to identify the parameters of supply and demand curves. Model heterogeneity is addressed using a clustering method to classify firms according to their production technology and observed price pass-through. We find that more productive firms have flatter marginal cost curves and exhibit a lower price response to changes in output. The aggregate price response to demand shocks will be smaller when more productive firms absorb a larger portion of demand shocks, which is generally the case. Further, idiosyncratic shifts in demand to clusters of firms with more rapidly rising marginal cost curves, or cost shocks to clusters of firms with high pass-through, could result in a higher aggregate price response. Finally, we provide a framework to incoporate incorporate firm-level heterogeneity into a NK macro model.