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 over-looked 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.