Adjustment Costs and Time-to-Build in Factor Demand in the US Manufacturing Industry

In order to explain cyclical behaviour of factor demand, the static neo-classical model of the firm has been extended to include either adjustment costs (e.g. Lucas (1967)) or time-to-build considerations as in Kydland and Prescott (1982). This paper presents an intertemporal factor demand model which accounts for adjustment costs and gestation lags. The closed form solution of the model is a highly restricted vector ARMA-process that is estimated using quarterly data for the manufacturing industry in the US 1960-1988. The main conclusion is that both sources of dynamics are identifyable and found to be empirically of importance