adjustment costs

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The costs of making changes in the economic variables one controls. Any economic agent, whether an individual, a firm, or a government, has preferences which determine what the optimal levels of the variables under their control would be, if they were free to make a fresh start in setting them. When actual levels differ from these optimal levels, adjustment costs must be considered. If adjustment costs are lump-sum, or increase proportionally or less than in proportion to the changes made in any one period, it will pay to make at once any change that is worth making at all. If adjustment costs increase more than proportionally to the size of the change, however, it pays to adjust only gradually. In adjusting its labour force, for example, a firm may find that small increases present no recruitment problem, and small decreases can be accommodated by natural wastage because of retirements and other voluntary departures, whereas rapid recruitment poses serious selection and training problems, and rapid decline involves redundancies, which are expensive and damaging to morale. See also menu costs.

Subjects: Economics.

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