Lumpy Capacity Investment and Disinvestment Dynamics

42 Pages Posted: 9 Apr 2008

Multiple version iconThere are 3 versions of this paper

Date Written: April 2008

Abstract

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.

Suggested Citation

Besanko, David A. and Doraszelski, Ulrich and Lu, Lauren Xiaoyuan and Satterthwaite, Mark A., Lumpy Capacity Investment and Disinvestment Dynamics (April 2008). Harvard Institute of Economic Research Discussion Paper No. 2154. Available at SSRN: https://ssrn.com/abstract=1117991 or http://dx.doi.org/10.2139/ssrn.1117991

David A. Besanko

Northwestern University - Kellogg School of Management ( email )

2211 Campus Drive
Evanston, IL 60208
United States
847-467-6505 (Phone)
847-467-1777 (Fax)

Ulrich Doraszelski (Contact Author)

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-495-2896 (Phone)
617-495-8570 (Fax)

University of Pennsylvania - Business & Public Policy Department

3641 Locust Walk
Philadelphia, PA 19104-6372
United States

Lauren Xiaoyuan Lu

Northwestern University - Kellogg School of Management - MEDS Department ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

HOME PAGE: http://www.kellogg.northwestern.edu/students/lauren-lu/

Mark A. Satterthwaite

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

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