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Uncertainty, Investment, and Industry Evolution

  • Ricardo J. Caballero
  • Robert S. Pindyck

We study the effects of aggregate and idiosyncratic uncertainty on the entry of firms, total investment, and prices in a competitive industry with irreversible investment. We first use standard dynamic programming methods to determine firms' entry decisions, and we describe the resulting industry equilibrium and its characteristics, emphasizing the effects of different sources of uncertainty. We then show how the conditional distribution of prices can be used as an alternative means of determining and understanding the behavior of firms and the resulting industry equilibrium. Finally, we use four-digit U.S. manufacturing data to examine some implications of the model.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4160.

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Date of creation: Sep 1992
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Publication status: published as International Economic Review, August 1996, vol. 37, no. 3, pp. 641-662.
Handle: RePEc:nbr:nberwo:4160
Note: EFG
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Phone: 617-868-3900
Web page: http://www.nber.org
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  1. Bertola, Guiseppe & Caballero, Ricardo J, 1994. "Irreversibility and Aggregate Investment," Review of Economic Studies, Wiley Blackwell, vol. 61(2), pages 223-46, April.
  2. Cabalero, R.J., 1997. "Aggregaete Investment," Working papers 97-20, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Hartman, Richard, 1972. "The effects of price and cost uncertainty on investment," Journal of Economic Theory, Elsevier, vol. 5(2), pages 258-266, October.
  4. Pindyck, Robert S., 1990. "Irreversibility, uncertainty, and investment," Working papers 3137-90., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  5. Bernanke, Ben S, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, MIT Press, vol. 98(1), pages 85-106, February.
  6. Dixit, A., 1988. "Entry And Exit Decisions Under Uncertainty," Papers 91, Princeton, Department of Economics - Financial Research Center.
  7. Saman Majd & Robert S. Pindyck, 1985. "Time to Build, Option Value, and Investment Decisions," NBER Working Papers 1654, National Bureau of Economic Research, Inc.
  8. Dixit, Avinash K, 1989. "Hysteresis, Import Penetration, and Exchange Rate Pass-Through," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 205-28, May.
  9. Pindyck, Robert S, 1988. "Irreversible Investment, Capacity Choice, and the Value of the Firm," American Economic Review, American Economic Association, vol. 78(5), pages 969-85, December.
  10. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
  11. Leahy, J.V., 1991. "The Optimality of Myopic Behaviour in a Competitive Model of Entry and Exit," Harvard Institute of Economic Research Working Papers 1566, Harvard - Institute of Economic Research.
  12. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
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