Abstract:

We study distortions to firm production along the intensive margin---how much to produce at each establishment or of each product---and the extensive margin---how many establishments or products to operate. Using data on the universe of Swedish establishments in services industries, we show that 1) size-dependent firm markups are just a symptom of size-dependent establishment markups, i.e., firms with larger establishments set higher markups but firms with more establishments do not, and 2) each successive establishment at a firm tends to be smaller relative to its municipality-industry. In a model of competition between firms through establishments, we characterize the distortions implied by establishment-level market power: firms inefficiently undervalue 1) production at larger establishments, 2) opening larger establishments, and 3) production at existing establishments relative to opening new establishments. Calibrated to our Swedish data, it is optimal to tax large high markup firms because they open too many establishments, contrary to findings from models with firm-level market power. Although a high markup indicates that a firm inefficiently produces too little at its existing establishments, it is a poor indicator of the efficiency of the firm's extensive margin.