A dynamic factor demand model is presented which pays special attention to the prevalence of a long‐term employment relationship in Japan. The model is based on the representation of technology by a variable cost function with adjustment costs for employment and capital stock, where the variable cost consists of the sum of overtime costs and materials costs. With employment being quasi‐fixed and scheduled hours institutionally regulated, short‐run adjustments are mostly made by overtime hours. Application to a time‐series data on the Japanese electrical machinery industry indicates quasi‐fixity of capital and employment and reproduces short‐run overshooting of overtime hours to compensate for the sluggish adjustment of employment.
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