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Endogenous Investment and Pricing under Uncertainty

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  • Young David

    () (University of Auckland)

Abstract

I analyze investment and pricing incentives in a differentiated products framework with uncertain demand. Firms choose production capacities before observing demand and choose prices after demand is realized. Unlike previous models, when firms are identical, symmetric pure-strategy equilibria exist, even in the presence of very low capacity costs. The equilibrium outcomes are significantly different from the equivalent Cournot model. Firms choose to underutilize their capacity at times of low demand, and hold more capacity than predicted by Cournot. I show with a simple policy example that even the sign of the comparative statics may differ between the two models.

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  • Young David, 2010. "Endogenous Investment and Pricing under Uncertainty," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 10(1), pages 1-29, January.
    • Handle: RePEc:bpj:bejtec:v:10:y:2010:i:1:n:1
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    References listed on IDEAS

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    1. Carl Davidson & Raymond Deneckere, 1986. "Long-Run Competition in Capacity, Short-Run Competition in Price, and the Cournot Model," RAND Journal of Economics, The RAND Corporation, vol. 17(3), pages 404-415, Autumn.
    2. James B. Bushnell & Erin T. Mansur & Celeste Saravia, 2008. "Vertical Arrangements, Market Structure, and Competition: An Analysis of Restructured US Electricity Markets," American Economic Review, American Economic Association, vol. 98(1), pages 237-266, March.
    3. Carlson, John A & McAfee, R Preston, 1983. "Discrete Equilibrium Price Dispersion," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 480-493, June.
    4. Reynolds, Stanley S. & Wilson, Bart J., 2000. "Bertrand-Edgeworth Competition, Demand Uncertainty, and Asymmetric Outcomes," Journal of Economic Theory, Elsevier, vol. 92(1), pages 122-141, May.
    5. James W. Friedman, 1988. "On the Strategic Importance of Prices versus Quantities," RAND Journal of Economics, The RAND Corporation, vol. 19(4), pages 607-622, Winter.
    6. Hogendorn Christian, 2007. "Tacit Collusion in Capacity Investment: The Role of Capacity Exchanges," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 7(1), pages 1-16, July.
    7. Veronika Grimm & Gregor Zoettl, 2006. "Capacity Choice under Uncertainty: The Impact of Market Structure," Working Paper Series in Economics 23, University of Cologne, Department of Economics.
    8. David M. Kreps & Jose A. Scheinkman, 1983. "Quantity Precommitment and Bertrand Competition Yield Cournot Outcomes," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 326-337, Autumn.
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    Cited by:

    1. Christiaan Behrens & Mark Lijesen, 2012. "Capacity Choice under Uncertainty with Product Differentiation," Tinbergen Institute Discussion Papers 12-113/VIII, Tinbergen Institute, revised 20 Feb 2014.

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