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A Unified Model of Investment under Uncertainty

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  • Abel, Andrew B
  • Eberly, Janice C

Abstract

This paper extends the theory of investment under uncertainty to incorporate fixed costs of investment, a wedge between the purchase price and sale price of capital, and potential irreversibility of investment. In this extended framework, investment is a nondecreasing function of q, the shadow price of installed capital. The optimal rate of investment is in one of three regimes (positive, zero, or negative gross investment), depending on the value of q relative to two critical values. In general, however, the shadow price q is not directly observable, so the authors present two examples relating q to observable variables. Copyright 1994 by American Economic Association.

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 84 (1994)
Issue (Month): 5 (December)
Pages: 1369-84

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Handle: RePEc:aea:aecrev:v:84:y:1994:i:5:p:1369-84

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  1. Lucas, Robert E, Jr & Prescott, Edward C, 1971. "Investment Under Uncertainty," Econometrica, Econometric Society, vol. 39(5), pages 659-81, September.
  2. Eberly, J.C., 1990. "Adjustment of Consumers'durables Stocks: Evidence from Automobile Purchases," Weiss Center Working Papers 22-91, Wharton School - Weiss Center for International Financial Research.
  3. Pindyck, Robert S, 1991. "Irreversibility, Uncertainty, and Investment," Journal of Economic Literature, American Economic Association, vol. 29(3), pages 1110-48, September.
  4. Treadway, Arthur B, 1969. "On Rational Entrepreneurial Behaviour and the Demand for Investment," Review of Economic Studies, Wiley Blackwell, vol. 36(106), pages 227-39, April.
  5. Sanford J Grossman & Guy Laroque, 2003. "Asset Pricing and Optimal Portfolio Choice in the Presence of Illiquid Durable Consumption Goods," Levine's Working Paper Archive 618897000000000803, David K. Levine.
  6. Pindyck, Robert S, 1982. "Adjustment Costs, Uncertainty, and the Behavior of the Firm," American Economic Review, American Economic Association, vol. 72(3), pages 415-27, June.
  7. Andrew B. Abel & Olivier J. Blanchard, 1983. "An Intertemporal Model of Saving and Investment," NBER Working Papers 0885, National Bureau of Economic Research, Inc.
  8. Bertola, Guiseppe & Caballero, Ricardo J, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Wiley Blackwell, vol. 61(2), pages 223-46, April.
  9. Mussa, Michael L, 1977. "External and Internal Adjustment Costs and the Theory of Aggregate and Firm Investment," Economica, London School of Economics and Political Science, vol. 44(174), pages 163-78, May.
  10. Rothschild, Michael, 1971. "On the Cost of Adjustment," The Quarterly Journal of Economics, MIT Press, vol. 85(4), pages 605-22, November.
  11. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
  12. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
  13. Fumio Hayashi, 1981. "Tobin's Marginal q and Average a : A Neoclassical Interpretation," Discussion Papers 457, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  14. Caballero, Ricardo J, 1991. "On the Sign of the Investment-Uncertainty Relationship," American Economic Review, American Economic Association, vol. 81(1), pages 279-88, March.
  15. Lam, Pok-sang, 1989. "Irreversibility and consumer durables expenditures," Journal of Monetary Economics, Elsevier, vol. 23(1), pages 135-150, January.
  16. Brunner, Karl & Meltzer, Allan H., 1980. "On the state of macroeconomics," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 12(1), pages 1-5, January.
  17. Robert E. Lucas & Jr., 1967. "Adjustment Costs and the Theory of Supply," Journal of Political Economy, University of Chicago Press, vol. 75, pages 321.
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