Dynamic Factor Demand: Frictions and Aggregate Productivity Effects

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AbstractDynamic Factor Demand: Frictions and Aggregate Productivity EffectsPI: Russell W. Cooper, University of Texas, SES-0819682This research studies the dynamics of capital and labor utilization and adjustment in the firm. The goal of the research is to specify and solve dynamic optimization problems of a firm, or its plants, taking into account the difficulties faced in adjusting capital and labor inputs. Capturing the complexity of this adjustment is one of the research accomplishments. One novel feature of the research is the use of an "Euler equation" continuous-optimization approach to estimation even though adjustment of the factors is intermittent. The project develops an approach for estimating the demand for capital in this way. Other research extends this approach to applications with occasionally binding constraints. This includes the study of a problem in which a firm faces financial restrictions which only bind in some states, and a household problem of limited access to capital markets.Understanding dynamic factor demand is quite important for policy purposes. For instance, the analysis of a reduction in the cost of capital through an investment tax credit, must be consistent with the nature of micro-level adjustment frictions. Otherwise, the predictions of the policy effects may be erroneous.Studies of aggregate productivity likewise need to take account of the significance of frictions in the reallocation of capital and labor. This research builds upon characterizations of the micro-level frictions to study the dynamics of aggregate productivity. Specifically, it provides an environment to evaluate the significance of endogenous reallocation costs for measured aggregate productivity. The methods developed then are applied to study productivity behavior during disruptions such as those caused by the Great Depression in the United States.