Endogenous capital utilization and productivity measurement in dynamic factor demand models Theory and an application to the U.S. electrical machinery industry

The literature on dynamic factor demand models has, until recently, largely overlooked the issue of capital utilization. In this paper we allow for variations in the rate of capital utilization within the context of a dynamic factor demand model by adopting a modeling framework within which the firm combines its beginning-of-period stocks with other inputs to produce its outputs as well as its end-of-period stocks. We also define measures of productivity and capacity utilization for the adopted framework. As a by-product, the framework also provides for a consistent decomposition of gross investment into replacement and expansion investment. As an illustration, the model is applied to U.S. electrical machinery data.