Adjustment costs and dynamic factor demand models: A presentation of two approaches applied to the U.S. cigarette manufacturing

Abstract

This paper makes use of the adjustment cost hypothesis to develop and compare the results of two dynamic input demand models applied to the U.S. cigarette manufacturing. One of the models presented in this paper is the flexible accelerator model and the other is the rational expectations model. In both models, capital and tobacco stocks are treated as potential quasi-fixed inputs and test are performed investigating if these inputs are subject to adjustment costs. The results obtained from the estimation of both models support the hypothesis that tobacco stock (by itself) is a quasi-fixed input but the hypothesis that capital stock (by itself) is a quasi-fixed input is not supported. The results of the rational expectations model support the hypothesis that capital and tobacco stocks together are subject to adjustment costs. Note that this hypothesis cannot be tested by the flexible accelerator model. The short-, intermediate-, and long-run elasticities of input substitution can be calculated from the statistical results. The own price elasticities produced by both models have the correct signs except for the long-run own price elasticity for materials generated by the rational expectations model which is positive. Both models generate similar in sign and magnitude short- and intermediate-run elasticities. Domestic and imported tobaccos appear to be short- and intermediate-run complements, in both models. Most of the long-run elasticities generated by both models differ in sign and magnitude. It is important to note that domestic and imported tobaccos appear to be long-run substitutes according to the flexible accelerator model but long-run complements based on the rational expectations model. A possible explanation of the production process provided by both models is that during the short- and intermediate-run, materials can substitute for domestic and imported tobaccos. In addition based only on the rational expectations model, capital stock may substitute for domestic tobacco in the intermediate run. In the long-run tobacco stock can substitute for domestic tobacco and it can be used together with imported tobacco in the production of cigarettes. The hypothesis that there is not any difference in marginal costs of producing cigarettes for domestic and foreign markets can be rejected in both models. Moreover, the hypothesis that the cigarette industry behaves competitively in the domestic and export markets cannot be rejected. Finally, there are statistical evidence supported by both models (and especially by the rational expectations model) that health information about the dangers of cigarette consumption and government advertising restrictions have negative effects on output demands. In addition both models agree on an inelastic domestic demand for cigarettes and on an elastic export demand.