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Competition and Irreversible Investments under Uncertainty

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  • Michele Moretto

    (Department of Economics, University of Brescia)

Abstract

This paper examines the effect of competition on the irreversible investment decisions under uncertainty as a generalization of the “real option” approach. We examine this issue with reference to an industry where each firm has only one investment opportunity which is completely irreversible and the product market reveals an inverted U-shape relationship between firm profits and industry size. That is, there are positive externalities for low level of the market size and negative externalities at high level of the market size. In the latter case, which corresponds to the traditional competitive industries, firms invest sequentially as market profitability develops. In the former case, which corresponds to industries in which investments are mutually beneficial, firms invest simultaneously after profitability of the market has developed sufficiently to capture all network benefits and to recover the option value of waiting. Put together, these extensions of the “real option” analysis, with strategic interactions, may help to explain both the cases of rapid and sudden developments such as the recent internet investments and the cases of prolonged start-up problems while waiting for the market to develop as the story of fax machines shows.

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Bibliographic Info

Paper provided by Fondazione Eni Enrico Mattei in its series Working Papers with number 2003.32.

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Date of creation: Mar 2003
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Handle: RePEc:fem:femwpa:2003.32

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Keywords: Competition; network effect; real options;

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Citations

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Cited by:
  1. Sergio Vergalli, 2006. "The Role of Community in Migration Dynamics," Working Papers 2006.4, Fondazione Eni Enrico Mattei.
  2. Sergio Vergalli, 2006. "Dynamics in Immigration Community," Working Papers ubs0613, University of Brescia, Department of Economics.
  3. Luca Corato & Michele Moretto & Sergio Vergalli, 2013. "Land conversion pace under uncertainty and irreversibility: too fast or too slow?," Journal of Economics, Springer, vol. 110(1), pages 45-82, September.
  4. Michele Moretto & Sergio Vergalli, 2010. "Managing Migration through Conflicting Policies: an Option-theory Perspective," "Marco Fanno" Working Papers 0110, Dipartimento di Scienze Economiche "Marco Fanno".
  5. Michele Moretto, 2003. "Competition and Irreversible Investments under Uncertainty," Working Papers 2003.32, Fondazione Eni Enrico Mattei.
  6. Michele Moretto & Sergio Vergalli, 2008. "Managing Migration through Quotas: an Option-theory Perspective," Working Papers 0805, University of Brescia, Department of Economics.
  7. Michele Moretto & Sergio Vergalli, 2005. "Migration dynamics," Working Papers ubs0507, University of Brescia, Department of Economics.
  8. Sergio Vergalli, 2011. "Entry and Exit Strategies in Migration Dynamics," Journal of Labor Research, Springer, vol. 32(4), pages 362-389, December.
  9. Gianluca Femminis & Gianmaria Martini, 2008. "Irreversible R&D investment with inter-firm spillovers," DISCE - Quaderni dell'Istituto di Teoria Economica e Metodi Quantitativi compila la segreteria, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
  10. Femminis, Gianluca & Martini, Gianmaria, 2011. "Irreversible investment and R&D spillovers in a dynamic duopoly," Journal of Economic Dynamics and Control, Elsevier, vol. 35(7), pages 1061-1090, July.

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