In Discussion Paper No. 1371, Daniel Hamermesh and Research Fellow Gerard Pfann pursue three goals: first, they illustrate the impact of various assumptions about the structure of adjustment costs, and infer what these imply for aggregation. In particular, they examine the implications of the standard quadratic-symmetric specification. Second, the authors discuss the issues involved in inferring the nature of adjustment costs, and review relevant empirical literature which shows that the standard assumptions are inferior to many alternatives. Some of their findings, they claim, have the potential to alter the way economists should think about factor adjustment. Third, they evaluate what is known about the central aspects of adjustment costs; their source, structure and size.

A concluding assessment of how adjustment costs should be treated in macroeconomic analysis follows. The importance of this new approach is demonstrated in the context of predicting macroeconomic fluctuations in employment and investment.

Adjustment Costs in Factor Demand
Daniel S Hamermesh and Gerard A Pfann