Expectations and Factor Demand

This paper develops and estimates a model of interrelated factor demand with rational expectations, in the presence of internal adjustment costs. Invariant technological parameters are distinguished from the firm's adjustment parameters, which change when the exogenous processes faced by the firm change. The capital demand equation is derived by solving the Euler equations which stem from minimization of the present value of costs. Future exogenous variables are supplied from solutions of ARIMA equations. The model is tested on postwar quarterly data for U.S. manufacturing. A Regime change in the process for energy prices is simulated, as is a temporary suspension of the investment tax credit.