The adjustment-cost model of investment provides a rigorous basis for deriving a firm's price elasticity of supply over various lengths of run. Moreover, parameters of the adjustment-cost function itself play a prominent role in determining the size of the elasticity over the medium and long run. In this article we demonstrate how to derive supply elasticities from the optimization problem of a firm and argue that correct treatment of adjustment costs is essential to obtaining realistic behavior from general equilibrium models.
ASJC Scopus subject areas
- Economics and Econometrics