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Lumpy Capacity Investment and Disinvestment Dynamics

  • Ulrich Doraszelski

    (Harvard University)

  • Mark Satterthwaite

    (Northwestern University)

  • Lauren Xiaoyuan Lu

    (University of North Carolina)

  • David Besanko

    (Northwestern University)

Registered author(s):

    Capacity addition and withdrawal decisions are among the most important strategic decisions made by firms in oligopolistic industries. In this paper, we develop and analyze a fully dynamic model of an oligopolistic industry with lumpy capacity and lumpy investment/disinvestment. We use our model to answer two questions. First, what economic factors facilitate preemption races? Second, what economic factors facilitate capacity coordination? We show that low product differentiation, low investment sunkness, and high depreciation promote preemption races. We also show that low product differentiation and low investment sunkness promote capacity coordination. Although depreciation removes capacity, it may impede capacity coordination. Finally, we show that, at least over some range of parameter values, firms' expectation plays a key role in determining whether or not industry dynamics are characterized by preemption races and capacity coordination. Taken together, our results suggest that preemption races and excess capacity in the short run often go hand-in-hand with capacity coordination in the long run.

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    File URL: https://www.economicdynamics.org/meetpapers/2009/paper_106.pdf
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    Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 106.

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    Date of creation: 2009
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    Handle: RePEc:red:sed009:106
    Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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    1. Gilbert, Richard J., 1987. "Investment and Coordination in Oligopolistic Industries," Department of Economics, Working Paper Series qt51b0f7sq, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    2. Beth Allen & Raymond Deneckere & Tom Faith & Dan Kovenock, 1994. "Capacity Precommitment as a Barrier to Entry:A Bertrand-Edgeworth Approach," Industrial Organization 9411002, EconWPA, revised 14 Nov 1994.
    3. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, June.
    4. Dan Kovenock & Raymond J. Deneckere, 1996. "Bertrand-Edgeworth duopoly with unit cost asymmetry (*)," Economic Theory, Springer, vol. 8(1), pages 1-25.
    5. Pankaj Ghemawat, 1997. "Games Businesses Play: Cases and Models," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262071827, June.
    6. Bernstein, Jeffrey I., 1991. "Price Margins and Capital Adjustment: Canadian Mill Products and Pulp and Paper Industries," Working Papers 91-42, C.V. Starr Center for Applied Economics, New York University.
    7. Andrew Wood, 2005. "Investment interdependence and the coordination of lumpy investments: evidence from the British brick industry," Applied Economics, Taylor & Francis Journals, vol. 37(1), pages 37-49.
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