Irreversible Investment with Uncertainty and Scale Economies
AbstractThis paper analyses optimal irreversible investment policy when profits are subject to a multiplicative geometric Brownian motion shock. The marginal product of capital is increasing initially and decreasing thereafter. In the latter range, optimal policy is familiar: capacity is added gradually as the shock rises to a threshold where the expected return on the marginal unit is a required multiple of the cost of capital. The multiple reflects the option value of waiting. The optimal policy in the increasing marginal product range obeys the same multiple, now applied to the total return on the discrete increase in capital. Implications for economic growth, and suboptimal equilibria under external economies, are examined.
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Bibliographic InfoPaper provided by Suntory and Toyota International Centres for Economics and Related Disciplines, LSE in its series STICERD - Theoretical Economics Paper Series with number 240.
Date of creation: 1992
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Web page: http://sticerd.lse.ac.uk/_new/publications/default.asp
Scale economies; uncertainty; optimal irreversible investment policy; capital; economic growth; profits.;
Other versions of this item:
- Dixit, Avinash, 1995. "Irreversible investment with uncertainty and scale economies," Journal of Economic Dynamics and Control, Elsevier, vol. 19(1-2), pages 327-350.
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