LINEAR-EXPONENTIAL ADJUSTMENT COSTS IN THE FORM OF LINEAR SPECIFICATION

A rockets and feathers hypothesis states that output price reactions are prompt when an input price rises, and output price reactions are small when an input price falls. Many method approaches study the hypothesis. This paper focuses on the method based on the linear-exponential form of the firm's adjustment costs. The first-order conditions of the firm expand to the linear econometric specification of input price reactions. The theory supposes coefficient restrictions. The paper verifies the supposition in Slovak and U.S. retail gasoline markets. The orthogonality conditions implied by the rational expectation hypothesis makes the generalized method of moments a natural candidate for estimating equation. The choice of instruments corresponds to the orthogonality test, the exogeneity test, and the weakness of instruments test. Estimating the equation and testing the restrictions, the results support the theory in both markets.