Dynamic factor demand schedules for labor and capital under rational expectations

Abstract

In this paper we investigate possible sources of aggregate cyclical asymmetry of production factor dynamics using a trivariate structural dynamic model of capital and labor demand and output. The two sources are: internal or behavioral asymmetry resulting from asymmetry in costs of adjusting factor inputs, and external non-linearity present in the process of real factor prices, being the model's forcing variables together with productivity shocks. In the empirical analysis behavioral asymmetry and external non-linearity are disentangled by estimation (GMM) and by simulation techniques. Simulated solutions of the model's nonlinear first order necessary conditions are obtained using an extended version of the parameterized expectations algorithm (PEA). Behavioral asymmetry accounts for about 50 percent of the curvature of adjustment costs and therefore contributes in an important way to the dynamics of production factors; external non-linearity on the contrary plays only a moderate role.