The Response of Prices, Sales, and Output to Temporary Changes

We determine empirically how the Big Three automakers accommodate shocks to demand. They have the capability to change prices, alter labor inputs through temporary layoffs and overtime, or adjust inventories. These adjustments are interrelated, non-convex, and dynamic in nature. Combining weekly plant-level data on production schedules and output with monthly data on sales and transaction prices, we estimate a dynamic profit-maximization model of the firm. Using impulse response functions, we demonstrate that automakers react to demand shocks with an immediate price response that is linear in the size of the shock, combined with multiple, delayed production responses that are non-convex in the size of the shock. The cumulative price and production responses over the product cycle are globally linear in the size of the shock though local nonlinearities survive aggregation. We examine two recent demand shocks: the Ford Explorer/Firestone tire recall of 2000, and the September 11, 2001 terrorist attacks.