A Markup Interpretation of Optimal Rules for Irreversible Investment
Princeton University - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)
Robert S. Pindyck
Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)
Agder University College
NBER Working Paper No. w5971
We re-examine the basic investment problem of deciding when to incur a sunk cost to obtain a stochastically fluctuating benefit. The optimal investment rule satisfies a trade-off between a larger versus a later net benefit; we show that this trade-off is closely analogous to the standard trade-off for the pricing decision of a firm that faces a downward sloping demand curve. We reinterpret the optimal investment rule as a markup formula involving an elasticity that has exactly the same form as the formula for a firm's optimal markup of price over marginal cost. This is illustrated with several examples.
Number of Pages in PDF File: 17
Date posted: July 8, 2000
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