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Adjustment Costs and Returns to Scale: Some Theoretical and Empirical Aspects

In specifying third generation models of factor demands, adjustment costs are frequently treated as a function of net rather than gross investment. Such specifications assume replacement investment is frictionless and in equilibrium adjustment costs are zero. Recognition that adjustment costs may reflect not only net but also gross investment leads to a more complex model. But the revised model implies increasing long-run average costs. Such a model can still be specified to impose constant long-run average costs, or constant returns to scale. The latter condition is often desirable to avoid confusion in estimating technological progress. However, empirical work suggests that conventionally labelled expressions of adjustment costs embrace other influences. Proper measurement and identification of such costs may well require more finely tuned approaches.

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Energy Specializations: Petroleum – Policy and Regulation; Energy Modeling – Other

JEL Codes: D24: Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity, Q41: Energy: Demand and Supply; Prices, D22: Firm Behavior: Empirical Analysis, C51: Model Construction and Estimation, Q40: Energy: General, C53: Forecasting Models; Simulation Methods

Keywords: Adjustment costs, Returns to scale, third generation models, Energy demand

DOI: 10.5547/ISSN0195-6574-EJ-Vol14-No1-11

Published in Volume 14, Number 1 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.


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