Working Paper: NBER ID: w9946
Authors: Robert G. King; Julia K. Thomas
Abstract: Many kinds of economic behavior appear to be governed by discrete and occasional individual choices. Despite this, econometric partial adjustment models perform relatively well at the aggregate level. Analyzing the classic employment adjustment problem, we show how discrete and occasional microeconomic adjustment is well described by a new form of partial adjustment model that aggregates the actions of a large number of heterogeneous producers. We begin by describing a basic model of discrete and occasional adjustment at the micro level, where production units are essentially restricted to either operate with a fixed number of workers or shut down. We show that this simple model is observationally equivalent at the market level to the standard rational expectations partial adjustment model. We then construct a related, but more realistic, model that incorporates the idea that increases or decreases in the size of an establishment's workforce are subject to fixed adjustment costs. In the market equilibrium of this model, employment responses to aggregate disturbances include changes both in employment selected by individual establishments and in the measure of establishments actively undertaking adjustment. Yet the model retains a partial adjustment flavor in its aggregate responses. Moreover, in contrast to existing models of discrete adjustment, our generalized partial adjustment model is sufficiently tractable to allow extension to general equilibrium.
Keywords: Partial Adjustment; Employment Dynamics; Labor Economics
JEL Codes: E1; E2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| individual production unit adjustments (L23) | aggregate employment dynamics (J69) |
| gap between current and desired employment levels (J68) | probability of adjustment for individual units (C29) |
| individual establishments face varying fixed costs of adjustment (D21) | timing in their adjustments (C41) |
| individual production units adjust their workforce (L23) | smooth aggregate employment demand (J23) |