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Competition and Irreversible Investments under Uncertainty

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  • Michele Moretto

    (Department of Economics, University of Brescia)

Abstract

This paper examines the effect of competition on the irreversible investment decisions under uncertainty as a generalization of the “real option” approach. We examine this issue with reference to an industry where each firm has only one investment opportunity which is completely irreversible and the product market reveals an inverted U-shape relationship between firm profits and industry size. That is, there are positive externalities for low level of the market size and negative externalities at high level of the market size. In the latter case, which corresponds to the traditional competitive industries, firms invest sequentially as market profitability develops. In the former case, which corresponds to industries in which investments are mutually beneficial, firms invest simultaneously after profitability of the market has developed sufficiently to capture all network benefits and to recover the option value of waiting. Put together, these extensions of the “real option” analysis, with strategic interactions, may help to explain both the cases of rapid and sudden developments such as the recent internet investments and the cases of prolonged start-up problems while waiting for the market to develop as the story of fax machines shows.

Suggested Citation

  • Michele Moretto, 2003. "Competition and Irreversible Investments under Uncertainty," Working Papers 2003.32, Fondazione Eni Enrico Mattei.
  • Handle: RePEc:fem:femwpa:2003.32
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    1. repec:kap:revaec:v:30:y:2017:i:4:d:10.1007_s11138-016-0368-6 is not listed on IDEAS
    2. M. Moretto & Sergio Vergalli, 2008. "Migration dynamics," Journal of Economics, Springer, vol. 93(3), pages 223-265, April.
    3. Michele Moretto & Sergio Vergalli, 2010. "Managing Migration Through Conflicting Policies: An Option-Theory Perspective," Scottish Journal of Political Economy, Scottish Economic Society, vol. 57(s1), pages 318-342, July.
    4. Sergio Vergalli, 2006. "Dynamics in Immigration Community," Working Papers ubs0613, University of Brescia, Department of Economics.
    5. Michele Moretto & Sergio Vergalli, 2008. "Managing Migration through Quotas: an Option-theory Perspective," Working Papers 2008.51, Fondazione Eni Enrico Mattei.
    6. Moretto, Michele, 2008. "Competition and irreversible investments under uncertainty," Information Economics and Policy, Elsevier, vol. 20(1), pages 75-88, March.
    7. Tamini, Lota Dabio, 2012. "Optimal quality choice under uncertainty on market development," Working Papers 148589, Structure and Performance of Agriculture and Agri-products Industry (SPAA).
    8. Tamini, Lota D., 2012. "Optimal quality choice under uncertainty on market development," MPRA Paper 40845, University Library of Munich, Germany.
    9. Femminis, Gianluca & Martini, Gianmaria, 2011. "Irreversible investment and R&D spillovers in a dynamic duopoly," Journal of Economic Dynamics and Control, Elsevier, vol. 35(7), pages 1061-1090, July.
    10. Sergio Vergalli, 2011. "Entry and Exit Strategies in Migration Dynamics," Journal of Labor Research, Springer, vol. 32(4), pages 362-389, December.
    11. Luca Corato & Michele Moretto & Sergio Vergalli, 2013. "Land conversion pace under uncertainty and irreversibility: too fast or too slow?," Journal of Economics, Springer, vol. 110(1), pages 45-82, September.
    12. Moretto, Michele & Vergalli, Sergio, 2008. "Managing Migration through Quotas: An Option-theory Perspective," Knowledge, Technology, Human Capital Working Papers 37818, Fondazione Eni Enrico Mattei (FEEM).
    13. Vergalli, Sergio, 2006. "The Role of Community in Migration Dynamics," Knowledge, Technology, Human Capital Working Papers 12080, Fondazione Eni Enrico Mattei (FEEM).
    14. Sergio Vergalli, 2008. "The Role of Community in Migration Dynamics," LABOUR, CEIS, vol. 22(3), pages 547-567, September.
    15. Gianluca Femminis & Gianmaria Martini, 2008. "Irreversible R&D investment with inter-firm spillovers," DISCE - Quaderni dell'Istituto di Teoria Economica e Metodi Quantitativi compila la segreteria, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).

    More about this item

    Keywords

    Competition; network effect; real options;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives

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