DP2557 | In-House Competition, Organizational Slack and the Business Cycle

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This paper analyses the impact of variations of product demand on the amount of internal slack in multi-plant firms in a model in which facilities can produce output at a privately known cost up to a previously-determined capacity level. In such a model, the amount of slack in the firm is shown to be pro-cyclical. Indeed, as capacity constraints become tighter in booms, slack increases in booms, because the power of in-house competition is reduced, while the opposite is true in downturns. Also, in downturns the firm may use high-cost facili-ties even when low-cost plants are not running at capacity.