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A Markup Interpretation of Optimal Investment Rules

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  • Dixit, Avinash
  • Pindyck, Robert S
  • Sodal, Sigbjorn

Abstract

The authors reexamine the basic investment problem of deciding when to incur a sunk cost to obtain a stochastically fluctuating benefit. The optimal investment rule satisfies a trade-off between a larger versus a later net benefit; they show that this trade-off is closely analogous to the standard trade-off for the pricing decision of a firm that faces a downward sloping demand curve. The authors reinterpret the optimal investment rule as a markup formula involving an elasticity that has exactly the same form as the formula for a firm's optimal markup of price over marginal cost. This is illustrated with several examples.

Suggested Citation

  • Dixit, Avinash & Pindyck, Robert S & Sodal, Sigbjorn, 1999. "A Markup Interpretation of Optimal Investment Rules," Economic Journal, Royal Economic Society, vol. 109(455), pages 179-189, April.
  • Handle: RePEc:ecj:econjl:v:109:y:1999:i:455:p:179-89
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