Input cost, capacity utilization, and substitution in the short run

Abstract. This article studies the behavior of input cost shares in an environment where labor is costly to adjust, materials can be adjusted at no cost and capital is fixed. A model relating cost shares with relative prices and adjustment costs is proposed, allowing joint estimation of the elasticity of substitution and the adjustment cost function, which is an unknown function of the capacity utiliza-tion. Based on a panel of more than 700 manufacturing firms, we find evidence of strong input share variations according to the degree of capacity utilization. The estimated shapes of adjustment costs curves of labor are in agreement with our theoretical model, and we obtain sensible elasticities of substitution esti-mates. Based on such estimates, we find evidence of a negative (positive) bias in downturns (recoveries) in conventional productivity growth measures. JEL classification: D24, E32 Key words: Capacity utilization, input shares, productivity measurement