The response of prices, sales, and output to temporary changes in demand

Abstract

We determine empirically how automakers accommodate shocks to demand. Using data on production, sales, and transaction prices, we estimate a dynamic profit maximization model of the firm. We demonstrate that when an automaker is hit with a vehicle-specific demand shock, sales respond immediately and prices respond very modestly. Further, when accounting for non‐convexities in the cost function, production responds with a delay. Over time, shocks are absorbed almost entirely through adjustments in sales and production rather than prices. We examine two recent demand shocks: the Ford Explorer/Firestone tire recall of 2000, and the 11 September 2001 terrorist attacks. Copyright (C) 2009 John Wiley & Sons, Ltd.