A Comparison of a Production Smoothing Model and a Dynamic Factor Demand Model with Inventories

In literature two types of models exist that aim at describing the production decision(s) of entrepreneurs, taking account of production costs and costs incurred by the existence of inventory stocks of final goods. One type is called the production smoothing models and the other type the factor demand models that include inventories. In this paper both types are discussed, compared with each other and estimated. The main results are that the factor demand model is preferred to the production smoothing model since (i) costs are more "structurally" specified by which more efficient parameter estimates are obtained and (ii) arbitrary normalisation rules are not needed. GMM estimation results obtained with data from French industrial sectors also corroborate the preference of the factor demand model.