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20 - Intertemporal Duality in the Adjustment Cost Model of the Firm

Published online by Cambridge University Press:  05 June 2012

Michael R. Caputo
Affiliation:
University of Central Florida
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Summary

This chapter builds directly on the last in developing a duality for the adjustment cost model of the firm. In particular, the current value form of the H-J-B equation given in Theorem 19.3 will be exploited to develop a method to derive the duality properties of the adjustment cost model of the firm. Moreover, we will establish envelope results that will allow the explicit construction of the feedback or closed-loop forms of the investment demand, variable input demand, and output supply functions, given a functional form for the current value optimal value function with known properties. The importance of such a development is monumental in dynamic economic theory for the reasons well summarized by Epstein (1981, page 82):

In static models, duality is a convenience. Demand functions cannot generally be determined explicitly from the technology but they are defined implicitly by first order conditions which can serve as the basis for estimation, though perhaps requiring complicated simultaneous equations techniques. Explicit solutions for calculus of variations problems are even rarer and the implicit representation of solutions generally involves a second order nonlinear differential equation (system) and non-trivial boundary conditions. The differential equation system can serve as the basis for estimation only if the generally unrealistic assumption is made that the firm does not revise its plans for several periods and continues along the same optimal path. Thus duality is indispensable for empirical work based on functional forms that are too complicated to be derived directly from the technology as explicit solutions of a problem of intertemporal optimization.

Type
Chapter
Information
Foundations of Dynamic Economic Analysis
Optimal Control Theory and Applications
, pp. 537 - 566
Publisher: Cambridge University Press
Print publication year: 2005

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References

Caputo, M. R. (2003), “The Comparative Dynamics of Closed-Loop Controls for Discounted Infinite Horizon Optimal Control Problems,” Journal of Economic Dynamics and Control, 27, 1335–1365CrossRefGoogle Scholar
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Epstein, L. G. (1981), “Duality Theory and Functional Forms for Dynamic Factor Demands,” Review of Economic Studies, 48, 81–96CrossRefGoogle Scholar
Epstein, L. G. and Denny, M. (1983), “The Multivariate Flexible Accelerator Model: Its Empirical Restrictions and an Application to U.S. Manufacturing,” Econometrica, 51, 647–674CrossRefGoogle Scholar
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Lasserre, P. and Ouellette, P. (1999), “Dynamic Factor Demands and Technology Measurement under Arbitrary Expectations,” Journal of Productivity Analysis, 11, 219–241CrossRefGoogle Scholar
McLaren, K. R. and Cooper, R. J. (1980), “Intertemporal Duality: Application to the Theory of the Firm,” Econometrica, 48, 1755–1762CrossRefGoogle Scholar
Silberberg, E. (1974), “A Revision of Comparative Statics Methodology in Economics, or How to Do Comparative Statics on the Back of an Envelope,” Journal of Economic Theory, 7, 159–172.CrossRefGoogle Scholar

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