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The Response of Prices, Sales, and Output to Temporary Changes in Demand

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Abstract

We determine empirically how the Big Three automakers accommodate shocks to demand. They have the capability to change prices, alter labor inputs through temporary layoffs and overtime, or adjust inventories. These adjustments are interrelated, non-convex, and dynamic in nature. Combining weekly plant-level data on production schedules and output with monthly data on sales and transaction prices, we estimate a dynamic profit-maximization model of the firm. Using impulse response functions, we demonstrate that when an automaker is hit with a demand shock sales respond immediately, prices respond gradually, and production responds only after a delay. The size of the immediate sales response is linear in the size of the shock, but the delayed production response is non-convex in the size of the shock. For sufficiently large shocks the cumulative production response over the product cycle is an order of magnitude larger than the cumulative price response. We examine two recent demand shocks: the Ford Explorer/Firestone tire recall of 2000, and the September 11, 2001 terrorist attacks.

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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1543.

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Length: 40 pages
Date of creation: Dec 2005
Date of revision:
Handle: RePEc:cwl:cwldpp:1543

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Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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Keywords: automobile pricing; inventories; revenue management; indirect inference;

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Cited by:
  1. Adam Copeland & James Kahn, 2013. "The Production Impact Of “Cash-For-Clunkers”: Implications For Stabilization Policy," Economic Inquiry, Western Economic Association International, vol. 51(1), pages 288-303, 01.
  2. McManus, Walter, 2007. "The link between gasoline prices and vehicle sales:economic theory trumps conventional Detroit wisdom," MPRA Paper 3463, University Library of Munich, Germany.
  3. Friberg, Richard & Huse, Cristian, 2012. "How to use demand systems to evaluate risky projects, with an application to automobile production," CEPR Discussion Papers 9266, C.E.P.R. Discussion Papers.
  4. Šustek, Roman, 2011. "Plant-level nonconvex output adjustment and aggregate fluctuations," Journal of Monetary Economics, Elsevier, vol. 58(4), pages 400-414.
  5. James Kahn & Adam Copeland, 2012. "Durable Goods Production and Inventory Dynamics: An Application to the Automobile Industry," 2012 Meeting Papers 270, Society for Economic Dynamics.
  6. Adam Copeland & James A. Kahn, 2012. "Exchange rate pass-through, markups, and inventories," Staff Reports 584, Federal Reserve Bank of New York.
  7. Florian Zettelmeyer & Fiona Scott Morton & Jorge Silva-Risso, 2006. "Scarcity Rents in Car Retailing: Evidence from Inventory Fluctuations at Dealerships," NBER Working Papers 12177, National Bureau of Economic Research, Inc.

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