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Output, Employment And Prices In An Economy With Adjustment Costs

  • Gil Mehrez

    (Georgetown University)

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    This paper investigates the dynamics of output, employment and prices in an economy with costs of adjusting labor and prices. In an economy with non convex adjustments costs, firms do not adjust labor and prices continuously to accommodate every shift in demand. Rather, firms adjust employment and prices discontinuously. Employment and prices are adjusted only after demand has shifted beyond a predetermined thresholds. When adjustment is discontinuous, the dynamics of the aggregate economy is very different from the behavior of a single firm. The dynamics of the price level, aggregate employment and output depend in a crucial way on the firms' distribution along the inaction intervals. This paper develops a model with infrequent price and labor adjustments. The firms' multivariate distribution of prices and employment deviation from their optimal level is derived and is used to determine the dynamics of the price level, aggregate employment and aggregate output. It is shown that in such economy money is not neutral.

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    Paper provided by EconWPA in its series Macroeconomics with number 9610003.

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    Date of creation: 24 Oct 1996
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    Handle: RePEc:wpa:wuwpma:9610003
    Note: Type of Document - WordPerfect; prepared on IBM PC ; to print on HP; pages: ; figures: included
    Contact details of provider: Web page: http://econwpa.repec.org

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    1. Giuseppe Bertola & Ricardo J. Caballero, 1990. "Kinked Adjustment Costs and Aggregate Dynamics," NBER Chapters, in: NBER Macroeconomics Annual 1990, Volume 5, pages 237-296 National Bureau of Economic Research, Inc.
    2. Julio J. Rotemberg, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Oxford University Press, vol. 49(4), pages 517-531.
    3. Yellen, Janet L, 1984. "Efficiency Wage Models of Unemployment," American Economic Review, American Economic Association, vol. 74(2), pages 200-205, May.
    4. Carlton, Dennis W, 1986. "The Rigidity of Prices," American Economic Review, American Economic Association, vol. 76(4), pages 637-58, September.
    5. Eytan Sheshinski & Yoram Weiss, 1983. "Optimum Pricing Policy under Stochastic Inflation," Review of Economic Studies, Oxford University Press, vol. 50(3), pages 513-529.
    6. Caballero, Ricardo J, 1992. "A Fallacy of Composition," American Economic Review, American Economic Association, vol. 82(5), pages 1279-92, December.
    7. Andrew Caplin & John Leahy, 1991. "State-Dependent Pricing and the Dynamics of Money and Output," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 683-708.
    8. Andrew S. Caplin & Daniel F. Spulber, 1987. "Menu Costs and the Neutrality of Money," The Quarterly Journal of Economics, Oxford University Press, vol. 102(4), pages 703-725.
    9. Caballero, Ricardo J & Engel, Eduardo M R A, 1991. "Dynamic (S, s) Economies," Econometrica, Econometric Society, vol. 59(6), pages 1659-86, November.
    10. Thomas J. Sargent, 1978. "Estimation of dynamic labor demand schedules under rational expectations," Staff Report 27, Federal Reserve Bank of Minneapolis.
    11. Laurence Ball & David Romer, 1990. "Real Rigidities and the Non-Neutrality of Money," Review of Economic Studies, Oxford University Press, vol. 57(2), pages 183-203.
    12. Robert E. Hall, 1986. "Market Structure and Macroeconomic Fluctuations," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 17(2), pages 285-338.
    13. George A. Akerlof & Janet L. Yellen, 1985. "A Near-Rational Model of the Business Cycle, with Wage and Price Inertia," The Quarterly Journal of Economics, Oxford University Press, vol. 100(Supplemen), pages 823-838.
    14. Katharine G. Abraham & Susan K. Taylor, 1993. "Firms' Use of Outside Contractors: Theory and Evidence," NBER Working Papers 4468, National Bureau of Economic Research, Inc.
    15. Ricardo J. Caballero & Eduardo Engel & John Haltiwanger, 1996. "Aggregate Employment Dynamics: Building from Microeconomic Evidence," Documentos de Trabajo 6, Centro de Economía Aplicada, Universidad de Chile.
    16. Samuel Bentolila & Giuseppe Bertola, 1990. "Firing Costs and Labour Demand: How Bad is Eurosclerosis?," Review of Economic Studies, Oxford University Press, vol. 57(3), pages 381-402.
    17. Robert J. Barro, 1972. "A Theory of Monopolistic Price Adjustment," Review of Economic Studies, Oxford University Press, vol. 39(1), pages 17-26.
    18. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June.
    19. N. Gregory Mankiw, 1985. "Small Menu Costs and Large Business Cycles: A Macroeconomic Model of Monopoly," The Quarterly Journal of Economics, Oxford University Press, vol. 100(2), pages 529-538.
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