Markups, pass-through, and firm heterogeneity with sequentially mixed search

The determination of firm- and industry-level market power is studied in a model with search frictions driven by matching and incomplete information and in which heterogeneous firms compete for sales to ex ante homogeneous buyers. Combining directed search and random meetings sequentially, market tightness and the distributions of prices and productivity across active firms are determined jointly in equilibrium. We relate firm-level variation in prices and markups to variation in the elasticity of demand at the firm level. These distributions respond endogenously to changes in variable costs, utility from consumption, fixed costs of both entry and operation, and the consumer search process. We refer to these responses as pass-through and characterize them for both individual firms and the industry average. We show further that owing to the equilibrium determination of market tightness and the price distribution in directed search, improvements in consumer welfare may be associated with either increases or decreases in average markups.