Many kinds of economic behavior appear to be governed by discrete and occasional individual choices. Despite this, econometric partial adjustment models perform relatively well at the aggregate level. Analyzing the classic employment adjustment problem, we show how discrete and occasional microeconomic adjustment is well described by a new form of partial adjustment model that aggregates the actions of a large number of heterogeneous producers facing fixed costs of factor adjustment. In the market equilibrium of this model, employment responses to aggregate disturbances include changes both in a target employment selected by establishments and in the measure of establishments actively adjusting to this target. Yet the model retains a partial adjustment flavor in its aggregate responses. Previous research involving discrete factor adjustment has been conducted almost exclusively under the assumption of exogenous prices, given the complications presented by nontrivial heterogeneity in production. We demonstrate how such complications can be limited, allowing both general equilibrium analysis and the convenience of linear solution methods. We also show how our framework is easily generalized to accommodate persistent idiosyncratic shocks. This generalization allows both greater consistency with the microeconomic dynamics of factor adjustment, as well as application to a much broader set of questions involving discrete individual choices, within a tractable equilibrium model.
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Length: 39 pages Date of creation: Feb 2005 Date of revision: Publication status: Forthcoming in International Economic Review Handle: RePEc:bos:macppr:wp2005-001
Robert G. King & Julia K. Thomas, 2006.
"Partial Adjustment Without Apology,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(3), pages 779-809, 08.
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Find related papers by JEL classification: E2 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
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Lucas, Robert E, Jr & Prescott, Edward C, 1971.
"Investment Under Uncertainty,"
Econometrica,
Econometric Society, vol. 39(5), pages 659-81, September.
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King, Robert G. & Rebelo, Sergio T., 1999.
"Resuscitating real business cycles,"
Handbook of Macroeconomics,
in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 14, pages 927-1007
Elsevier.
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