CAPACITY AND ASYMMETRIES IN MONETARY POLICY
optimal production level of the final firm (Pt is indeterminate. However, when some
input is supply-constrained, the final good price is larger than the input price.
As a result, the spillover term (Fyt∕Pt) 6is larger than one. This term is going to
play a significant role in the model’s behavior, as will be stressed later.
2.2. Intermediate Good Firms. In this sector, each intermediate good is pro-
duced by a monopolistically competitive firm making use of capital and labor,
which are combined for production through a putty-clay technology. Intermediate
firms start period t with a predetermined level of capacity. Such a production plan
cannot be adapted to the needs of the firm within the period. Hence, investment
achieved during period t - 1 becomes productive at date t. Investment consists of
the design of a production plan by simultaneously choosing a quantity of capital
goods Kjtt and employment capacity Njtt according to the following Cobb-Douglas
technology:
(2.10) ‰ = AtK*tN⅛a
where 0 < a < 1. The term At is the aggregate productivity parameter, capturing
total factor productivity. The variable Njtt represents the maximum number of
available work-stations in the firm. Hence, the firm is at full capacity when all
these work-stations are operating full-time. As it is common in models featuring a
putty-clay technology, it is convenient to express investment decision as the choice
of both Kjtt and a capital-labor ratio Xjtt ≡ Kjtt∕Njtt. Consequently, the expression
in (2.10) can be rewritten as
(2-11) YjU = AtX^1Kju
from where the technical productivity of the installed equipments can be deduced.
For the case of capital, it is given by AtX°1^~1, whereas AtX“t represents that of
labor, so that this production function displays constant returns-to-scale in the
within-period labor. In particular, if the firm uses a quantity of labor Ldt smaller
than Njtt, it then produces AtXtjtLdt units of intermediate good. Once the id-
iosyncratic (demand) shock Vjtt is revealed, the firm instantaneously adjusts its
labor demand Ld t to cover the needs of its production plan, lyt, that is,
fel2∙ l∙'<=⅛ = ⅛ mi" {y∙t⅛∙ (¾) ∙ Ц ∙
In order to finance such productive activities, intermediate good firms must borrow
the necessary amount of money from a financial intermediary since cash earnings
do not arrive in time to finance the period wage bill. Specifically, firms rent labor
at a wage Wt which is paid with cash obtained from the financial intermediary at
an interest rate R1j > 0. At the end of the period, the firm pays back the loan and
the interests: ΠztF-t(l + Rt ).
After observing the aggregate shocks, but before knowing the idiosyncratic one,
input producing firms take their price decisions. Input prices are announced on
the basis of (rational) expectations, before the exact value of the demand for their
production is realized. This price-setting assumption has the advantage of giving