T HE presence of adjustment costs for a firm altering its labour force or capital stock creates considerable problems for econometric work involving firm behaviour, either on the employment or the investment side. The usual way of handling these costs is to derive a so-called desired level for the choice variables based on an optimization assuming there are no adjustment costs and then to add an ad hoc lagged adjustment process, the nature of which however is not derived explicitly from the actual costs of adjustment. There are two problems with this. First, as noted by Nerlove (1972), the resulting paths would not in general be optimal for a profitmaximizing firm so there is an inconsistency between equilibrium behaviour and adjustment behaviour. Second, by allowing the adjustment process to be data determined without imposing the restrictions implied by optimization over adjustment costs, one makes it harder to discriminate between models on the basis of the data. This makes it difficult to test the appropriateness of assumptions about the underlying economic model (for example, the form of the production function used). The problem with including the adjustment costs in the optimization is of course that it leads to formulations that are intractable for empirical work. This paper is an attempt to avoid that problem by looking more carefully at labour costs and to see what can be said about the underlying production model without using ad hoc dynamic assumptions. In particular it recognizes the fact that, even for small firms, the wage rate for operatives is a step function in hours worked; up to a certain number of normal hours an operative is paid at one hourly wage rate but above that number of hours is paid at a higher, overtime rate. Of course, a firm would only use labour at the overtime rate if it cost less overall than hiring more labour at the normal rate. But since firms do regularly employ overtime labour, this suggests that they must face either a rising supply curve for labour or else a fixed cost in hiring additional employees; Since the latter enables one to retain price-taking behaviour in the labour market and can also provide an explanation for short-time working, that is what will be investigated here. What is relevant to the production decisions of a firm is of course the marginal cost of an additional hour of labour, provided, that is, that the average cost is not so high that it is unprofitable to produce at all. For a firm that has employees on short-time working, the marginal cost is the normal hourly wage rate. For a firm with employees on overtime, the marginal cost is the hourly overtime rate. These observations are formalized in the next section of the paper. In succeeding sections they are applied to models based on the Constant Elasticity of Substitution (CES) production function and to the vintage model of Malcomson and Prior (1979).