The reserve-labor hypothesis, short-run pricing theories, and the employment-output relationship

Abstract

Short-run price, output, and employment adjustments are studied jointly - in a latent-variable framework - to estimate the effects of unobservable demand and cost conditions. Drawing on the firm-specific human capital and implicit contracts literatures, a microeconomic analysis of firms with hoarded labor guides the econometrics and provides a basis for distinguishing between neoclassical and behavioral pricing. Data from U.S. manufacturing during the 1974-75 recession provide substantial indication of labor hoarding and marginalist pricing, while also suggesting that ‘short-run increasing returns to labor’ are a statistical illusion. Analysis of the same data, ignoring measurement error, suggests very different, and very conventional, inferences.