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This paper develops a model of firm behavior under uncertainty designed to study the interac tion of inventories and layoffs. The model is a blend of a buffer sto ck model of inventory behavior and an implicit contract model of layo ffs. The model creates a distinction between inventory-biased and lay off-biased firms, each of which exhibits inherently different pattern s of response of inventories and temporary layoffs to demand shocks. In addition, the model implies that the inventory-layoff interaction tends to strengthen (weaken) the response of price and the work force to changes in anticipated demand (real interest rates).
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Haltiwanger et al. (1988) studied this question.
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