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Lumpy Capacity Investment and Disinvestment Dynamics

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  • Ulrich Doraszelski

    (Harvard University)

  • Mark Satterthwaite

    (Northwestern University)

  • Lauren Xiaoyuan Lu

    (University of North Carolina)

  • David Besanko

    (Northwestern University)

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    Abstract

    Capacity addition and withdrawal decisions are among the most important strategic decisions made by firms in oligopolistic industries. In this paper, we develop and analyze a fully dynamic model of an oligopolistic industry with lumpy capacity and lumpy investment/disinvestment. We use our model to answer two questions. First, what economic factors facilitate preemption races? Second, what economic factors facilitate capacity coordination? We show that low product differentiation, low investment sunkness, and high depreciation promote preemption races. We also show that low product differentiation and low investment sunkness promote capacity coordination. Although depreciation removes capacity, it may impede capacity coordination. Finally, we show that, at least over some range of parameter values, firms' expectation plays a key role in determining whether or not industry dynamics are characterized by preemption races and capacity coordination. Taken together, our results suggest that preemption races and excess capacity in the short run often go hand-in-hand with capacity coordination in the long run.

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    Bibliographic Info

    Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 106.

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    Date of creation: 2009
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    Handle: RePEc:red:sed009:106

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    1. Dan Kovenock & Raymond J. Deneckere, 1996. "Bertrand-Edgeworth duopoly with unit cost asymmetry (*)," Economic Theory, Springer, vol. 8(1), pages 1-25.
    2. Dan Kovenock & Raymond Deneckere & Tom Faith & Beth Allen, 2000. "Capacity precommitment as a barrier to entry: A Bertrand-Edgeworth approach," Economic Theory, Springer, vol. 15(3), pages 501-530.
    3. Richard J. Gilbert and Marvin Lieberman., 1987. "Investment and Coordination in Oligopolistic Industries," Economics Working Papers 8730, University of California at Berkeley.
    4. Pankaj Ghemawat, 1997. "Games Businesses Play: Cases and Models," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262071827, December.
    5. Jeffrey I. Bernstein, 1992. "Price Margins and Capital Adjustment: Canadian Mill Products and Pulp and Paper Industries," NBER Working Papers 3982, National Bureau of Economic Research, Inc.
    6. Andrew Wood, 2005. "Investment interdependence and the coordination of lumpy investments: evidence from the British brick industry," Applied Economics, Taylor & Francis Journals, vol. 37(1), pages 37-49.
    7. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, December.
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