Industry Dynamics with Adjustment Costs

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Adjustment costs determine the dynamics of the response of an industry's output to a shift in demand. Absent any adjustment costs, an increase in demand not accompanied by any change in factor prices raises output, labor, capital, and materials in the same proportion. In the presence of adjustment costs, the elasticity of the response of factors with higher costs is less than one while the elasticity of those without adjustment costs exceeds one. I develop a model of industry dynamics to capture these properties and a related econometric framework to infer adjustment costs from the observed ratios of factor responses to output responses. I find relatively precise evidence of moderate adjustment costs.

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