OUTPUT, EMPLOYMENT AND PRICES IN AN ECONOMY WITH ADJUSTMENT COSTS

Gil Mehrez
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Gil Mehrez: Georgetown University

Macroeconomics from EconWPA

Abstract: This paper investigates the dynamics of output, employment and prices in an economy with costs of adjusting labor and prices. In an economy with non convex adjustments costs, firms do not adjust labor and prices continuously to accommodate every shift in demand. Rather, firms adjust employment and prices discontinuously. Employment and prices are adjusted only after demand has shifted beyond a predetermined thresholds. When adjustment is discontinuous, the dynamics of the aggregate economy is very different from the behavior of a single firm. The dynamics of the price level, aggregate employment and output depend in a crucial way on the firms' distribution along the inaction intervals. This paper develops a model with infrequent price and labor adjustments. The firms' multivariate distribution of prices and employment deviation from their optimal level is derived and is used to determine the dynamics of the price level, aggregate employment and aggregate output. It is shown that in such economy money is not neutral.

JEL-codes: E10 E23 E24 E31 E32 (search for similar items in EconPapers)
Date: Written 1996-10-24
Note: Type of Document - WordPerfect; prepared on IBM PC ; to print on HP; pages: ; figures: included
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