Shutdown Decision of Firms Based on Variable Costs and Demand

Abstract

The forest products industry in Alabama, the second largest manufacturing sector of the state, has been experiencing a recession in production, number of establishments and employees since the mid-1990s. This study investigates the determinants of this decline in the industry, using a county-level panel dataset that spans the period between 1996 and 2012. Four sub-sectors were analyzed separately, including the logging, wood, paper, and furniture manufacturing sectors. Results suggest that increases in average variable cost, rather than decreases in demand, were more strongly associated with the recession as measured by the number of operating establishments. Decomposition analysis indicates that the cost of materials, rather than labor, contributes more to the decline in the number of forest sector establishments in the state. This could be because increases in labor costs, such as wage increases, are accompanied by increases in labor productivity.