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Competition and Irreversible Investments under Uncertainty

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Author Info
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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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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Related research
Keywords: Competition network effect real options

Find related papers by JEL classification:
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
O31 - Economic Development, Technological Change, and Growth - - Technological Change - - - Innovation and Invention: Processes and Incentives

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Huisman, K.J.M. & Kort, P.M., 1999. "Effects of strategic interactions on the option value of waiting," Discussion Paper 92, Tilburg University, Center for Economic Research. [Downloadable!]
  2. Grenadier, Steven R, 1996. " The Strategic Exercise of Options: Development Cascades and Overbuilding in Real Estate Markets," Journal of Finance, American Finance Association, vol. 51(5), pages 1653-79, December. [Downloadable!] (restricted)
  3. Lee, In Ho & Mason, Robin, 2001. "Market structure in congestible markets," European Economic Review, Elsevier, vol. 45(4-6), pages 809-818, May. [Downloadable!] (restricted)
  4. Simon, Leo K & Stinchcombe, Maxwell B, 1989. "Extensive Form Games in Continuous Time: Pure Strategies," Econometrica, Econometric Society, vol. 57(5), pages 1171-1214, September. [Downloadable!] (restricted)
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  5. Nielsen, Martin J., 2002. "Competition and irreversible investments," International Journal of Industrial Organization, Elsevier, vol. 20(5), pages 731-743, May. [Downloadable!] (restricted)
  6. Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June. [Downloadable!] (restricted)
  7. Bernheim, B. Douglas & Peleg, Bezalel & Whinston, Michael D., 1987. "Coalition-Proof Nash Equilibria I. Concepts," Journal of Economic Theory, Elsevier, vol. 42(1), pages 1-12, June. [Downloadable!] (restricted)
  8. Bartolini, Leonardo, 1993. "Competitive runs : The case of a ceiling on aggregate investment," European Economic Review, Elsevier, vol. 37(5), pages 921-948, June. [Downloadable!] (restricted)
  9. Moretto, Michele, 2000. "Irreversible investment with uncertainty and strategic behavior," Economic Modelling, Elsevier, vol. 17(4), pages 589-617, December. [Downloadable!] (restricted)
  10. Mason, Robin & Weeds, Helen, 2001. "Irreversible Investment with Strategic Interactions," CEPR Discussion Papers 3013, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  11. Leahy, John V, 1993. "Investment in Competitive Equilibrium: The Optimality of Myopic Behavior," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1105-33, November. [Downloadable!] (restricted)
  12. repec:fth:tilbur:9992 is not listed on IDEAS
  13. Dixit, Avinash, 1995. "Irreversible investment with uncertainty and scale economies," Journal of Economic Dynamics and Control, Elsevier, vol. 19(1-2), pages 327-350. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Sergio Vergalli, 2006. "Dynamics in Immigration Community," Working Papers ubs0613, University of Brescia, Department of Economics. [Downloadable!]
  2. Michele Moretto & Sergio Vergalli, 2005. "Migration dynamics," Working Papers ubs0507, University of Brescia, Department of Economics. [Downloadable!]
    Other versions:
  3. Michele Moretto, 2007. "Competition and Irreversible Investments under Uncertainty," "Marco Fanno" Working Papers 0058, Dipartimento di Scienze Economiche "Marco Fanno". [Downloadable!]
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