We investigate the causal response of markup to a contraction in local demand and supply by comparing the response to these shocks across sectors characterized by different degrees of local competition. We exploit firm-level data and a natural experiment framework based on the implications of Italian anti-mafia legislation that allows us to consider episodes of unanticipated city-council dismissal as a contraction in demand and of firm seizure as a contraction in supply.
The results show that a contraction in demand tends to shrink the markups of differentiated manufacturing goods, transport and business services that are not affected by strong local competition, whereas it reduces labour costs for the retail, wholesale, accommodation and food (more competitive sectors), without any effect on markups. A contraction in supply boosts markups heterogeneously among firms.
