Irreversible Investment with Uncertainty and Scale Economies

27 Pages Posted: 16 Jul 2008

See all articles by Avinash Dixit

Avinash Dixit

Princeton University - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: May 1992

Abstract

This paper analyses optimal irreversible investment policy when profits are subject to a multiplicative geometric Brownian motion shock. The marginal product of capital is increasing initially and decreasing thereafter. In the latter range, optimal policy is familiar: capacity is added gradually as the shock rises to a threshold where the expected return on the marginal unit is a required multiple of the cost of capital. The multiple reflects the option value of waiting. The optimal policy in the increasing marginal product range obeys the same multiple, now applied to the total return on the discrete increase in capital. Implications for economic growth, and suboptimal equilibria under external economies, are examined.

JEL Classification: D20, D80, H11, H70, L22, P11

Suggested Citation

Dixit, Avinash K., Irreversible Investment with Uncertainty and Scale Economies (May 1992). LSE STICERD Research Paper No. TE240, Available at SSRN: https://ssrn.com/abstract=1160949

Avinash K. Dixit (Contact Author)

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States
609-258-4000 (Phone)
609-258-6419 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

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