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Capacity, volume flexibility, and costs

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  • Zhang, Anzhou

Abstract

This paper studies strategic firms' capacity choices in the presence of demand uncertainty and imperfect downside and upside volume flexibility. It provides conditions under which firms' capacity is greater or less than their expected output. It shows under certain conditions, a first-order stochastically dominant demand distribution induces higher capacity, while a mean-preserving spread of a demand distribution induces lower capacity. By endogenizing volume flexibility, it shows that firms' downside flexibility tends to be lower than their upside flexibility. This implies a firm's short-run average cost tends to be asymmetrically U-shaped, namely, the average cost increases more when output falls below capacity (the efficient scale) than when output rises above capacity by an equivalent amount.

Suggested Citation

  • Zhang, Anzhou, 2024. "Capacity, volume flexibility, and costs," International Journal of Industrial Organization, Elsevier, vol. 97(C).
  • Handle: RePEc:eee:indorg:v:97:y:2024:i:c:s0167718724000511
    DOI: 10.1016/j.ijindorg.2024.103096
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    More about this item

    Keywords

    Adjustment costs; Capacity investment; Volume flexibility;
    All these keywords.

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms

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