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Capacity Investment under Demand Uncertainty. An Empirical Study of the US Cement Industry, 1994-2006

  • Jean-Pierre Ponssard
  • Catherine Thomas

Uncertainty about the level of demand is thought to influence irreversible capacity decisions. This paper examines some implications of the theory literature on this topic in an empirical study of the US cement industry between 1994 and 2006. Firms in this sector have the ability to deliver cement either from domestic plants or from imports. Since cement is costly to transport via land, the difference in marginal cost between local production and imports varies across local markets. The marginal cost of imports is lower in areas with access to a sea port, decreasing the relative value of investing in local capacity sufficient to supply positive local demand shocks. In the presence of uncertain demand, firms may choose to serve these markets via both domestic production and imports. Consistent with the theory, we find a negative relationship between the average level of excess capacity and demand volatility only for coastal areas. An increase in demand volatility is associated with an increase in excess capacity only in landlocked areas. More generally, the paper shows that the cost of imports relative to the cost of domestic production affects the relationship between uncertainty and domestic capacity decisions. The results suggest that a unilateral climate policy in the US may induce a partial international relocation of capacity in carbon intensive industries, such as cement, by increasing the relative cost of domestic production.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3166.

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Date of creation: 2010
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Handle: RePEc:ces:ceswps:_3166
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  1. Henry, Claude, 1974. "Investment Decisions Under Uncertainty: The "Irreversibility Effect."," American Economic Review, American Economic Association, vol. 64(6), pages 1006-12, December.
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  6. Alberto Salvo, 2010. "Inferring market power under the threat of entry: the case of the Brazilian cement industry," RAND Journal of Economics, RAND Corporation, vol. 41(2), pages 326-350.
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  8. Guy Meunier & Jean-Pierre Ponssard, 2013. "Capacity decisions with demand fluctuations and carbon leakage," Working Papers hal-00347650, HAL.
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  10. Damien Demailly & Philippe Quirion, 2006. "CO2 abatement, competitiveness and leakage in the European cement industry under the EU ETS: Grandfathering vs. output-based allocation," Post-Print halshs-00639327, HAL.
  11. De Perthuis, Christian & Convery, Frank J. & Ellerman, Denny, 2010. "Pricing carbon : the European Union Emissions Trading Scheme," Economics Papers from University Paris Dauphine 123456789/10174, Paris Dauphine University.
  12. Alan Carruth & Andy Dickerson & Andrew Henley, 1998. "What Do We Know About Investment Under Uncertainty?," Studies in Economics 9804, School of Economics, University of Kent.
  13. repec:bla:restud:v:74:y:2007:i:2:p:391-415 is not listed on IDEAS
  14. Favero, Carlo A & Pesaran, M Hashem & Sharma, Sunil, 1994. "A Duration Model of Irreversible Oil Investment: Theory and Empirical Evidence," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 9(S), pages S95-112, Suppl. De.
  15. Hurn, A S & Wright, Robert E, 1994. "Geology or Economics? Testing Models of Irreversible Investment Using North Sea Oil Data," Economic Journal, Royal Economic Society, vol. 104(423), pages 363-71, March.
  16. Demers, Michel, 1991. "Investment under Uncertainty, Irreversibility and the Arrival of Information over Time," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 333-50, April.
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