Hours and Employment in a Stochastic Model of the Firm

This paper studies how firms adapt hours and employment to changes in business conditions. For this purpose we build a formal model which accounts for dynamic uncertainty and costly adjustments on both margins of the labour input. Using stochastic methods we find that the optimal employment policy is characterised by inaction as long as hours remain within an interval which includes standard working time. As a consequence, hiring and firing take place only when hours reach the upper and the lower boundaries of the interval. We also apply the model to a study of the impact of worksharing and find that such arrangements not only make firms more reluctant to fire in bad times but also more willing to hire when business conditions improve.