Idiosyncratic Uncertainty, Capacity Utilization and the Business Cycle
In a stochastic dynamic general equilibrium framework, we introduce the concept of variable capacity utilization (as opposed to the concept of capital utilization). We consider an economy where imperfectly competitive firms use a putty-clay technology and decide on their productive capacity level under uncertainty. An idiosyncratic uncertainty about the exact position of the demand curve faced by each firm explains why some productive capacities may remain idle in the sequel and why individual capacity utilization rates differ across firms. The capacity under-utilization at the aggregate level thus hides a diversity of microeconomic situations. The variablity of the capacity utilization allows for a good description of some of the main stylized facts of the busines cycle, propagates and magnifies aggregate technological shocks and generates endogenous persistence (i.e., the output growth rate displays positive serial correlation).
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