NBER Working Paper No. 1995 (Also Reprint No. r0824)
This paper tests New Classical and Keynesian explanations of
output determination within an encompassing "factor utilization"
model wherein the output decision by producers is modelled as the
choice of a utilization rate for employed factors. In this
encompassing model, the ratio of actual to normal output (with
the latter defined by a nested CES vintage production function
with capital, energy and employment as factor inputs) is
explained by unexpected sales (a Keynesian element), abnormal
profitability (one component of which is the Lucas "price
surprise" effect), and abnormal inventories.
Results using Canadian data show that the Keynesian and New
Classical elements contribute explanatory power, as does the
production-function-based measure of normal output, while each of
these partial models is strongly rejected in favour of the
encompassing model. The highly structured factor utilization
model is also seen to fit better than an unstructured VAR model.
U.S. data confirm the results, and show that there are
significant effects from abnormal demand, profitability and
inventory levels even if the labour and capital components of
normal output are defined using hours and utilized capital rather
than employment and the capital stock. The results are also
confirmed using alternative output (and hence input) concepts,
using a translog function instead of a CES function to define
normal output, and using data for several other major industrial
Published: "Supply-side Macro-economics." From Canadian Journal of Economics, Vol. 19, No. 4, pp. 597-625, (November 1986).