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Investment and Capacity Utilisation in a Putty-Clay Framework

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  • Kevin Lee
  • Paul Mizen
  • Michael Mahony

Abstract

This paper extends the classic Abel (1981) paper to introduce capacity utilisation into a dynamic model with adjustment costs describing investment and hiring decisions of the firm. We provide an analytical solution for the theoretical model and then use survey data form the CBI Industrial Trends Survey to test the model empirically. The results show that firms adjust their capital stock around a long-run equilibrium determined by sales over time. However, the speed of this adjustment depends on whether the model accounts for a capacity error correction term. Specifically, models which do not include a capacity error correction term overestimate the error correcting behaviour of firms, and imply a quicker adjustment speed of capital to its long-run equilibrium value. In other words, excluding capacity dynamics from an accelerator model of investment underestimates the time it takes capital to return to its long-run equilibrium value – providing an explanation for sluggish investment following recessionary periods.

Suggested Citation

  • Kevin Lee & Paul Mizen & Michael Mahony, 2022. "Investment and Capacity Utilisation in a Putty-Clay Framework," Economic Statistics Centre of Excellence (ESCoE) Discussion Papers ESCoE DP-2022-03, Economic Statistics Centre of Excellence (ESCoE).
    • Handle: RePEc:nsr:escoed:escoe-dp-2022-03
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    References listed on IDEAS

    as
    1. Abel, Andrew B & Eberly, Janice C, 1994. "A Unified Model of Investment under Uncertainty," American Economic Review, American Economic Association, vol. 84(5), pages 1369-1384, December.
    2. Jacques Mairesse & Bronwyn H. Hall & Benoît Mulkay, 1999. "Firm-Level Investment in France and the United States: An Exploration of What We Have Learned in Twenty Years," Annals of Economics and Statistics, GENES, issue 55-56, pages 27-67.
    3. Stephen Bond & Julie Ann Elston & Jacques Mairesse & Benoît Mulkay, 2003. "Financial Factors and Investment in Belgium, France, Germany, and the United Kingdom: A Comparison Using Company Panel Data," The Review of Economics and Statistics, MIT Press, vol. 85(1), pages 153-165, February.
    4. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
    5. Bean, Charles R, 1981. "An Econometric Model of Manufacturing Investment in the UK," Economic Journal, Royal Economic Society, vol. 91(361), pages 106-121, March.
    6. Bassetto, Camila F. & Kalatzis, Aquiles E.G., 2011. "Financial distress, financial constraint and investment decision: Evidence from Brazil," Economic Modelling, Elsevier, vol. 28(1), pages 264-271.
    7. repec:adr:anecst:y:1999:i:55-56:p:02 is not listed on IDEAS
    8. Bassetto, Camila F. & Kalatzis, Aquiles E.G., 2011. "Financial distress, financial constraint and investment decision: Evidence from Brazil," Economic Modelling, Elsevier, vol. 28(1-2), pages 264-271, January.
    9. Vivek Ghosal & Prakash Loungani, 2000. "The Differential Impact of Uncertainty on Investment in Small and Large Businesses," The Review of Economics and Statistics, MIT Press, vol. 82(2), pages 338-343, May.
    10. Driver, Ciaran & Temple, Paul & Urga, Giovanni, 2008. "Real options -- delay vs. pre-emption: Do industrial characteristics matter?," International Journal of Industrial Organization, Elsevier, vol. 26(2), pages 532-545, March.
    11. Andrew B. Abel, 1981. "A Dynamic Model of Investment and Capacity Utilization," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 96(3), pages 379-403.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    capacity utilisation; investment; putty-clay model;
    All these keywords.

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D25 - Microeconomics - - Production and Organizations - - - Intertemporal Firm Choice: Investment, Capacity, and Financing
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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