Investment under Uncertainty and the Recipient of the Entry Cost

Abstract

A typical model of investment under uncertainty, where firms pay an irreversible cost in order to produce, is studied. The analysis has a novel focus on the recipient of this payment, which is modeled as a firm or government that sells a resource (or a right) necessary for the production of the final good. Our main finding is that the resource owner may choose to set the price of the resource at a level high enough so as to cause the producers of the final good to delay their purchase of the resource and withhold production. The resource owner does so because it expects increased demand for the final good in the future. Another important result is that the price of the resource is a decreasing function of the elasticity of demand for the final good.

Keywords: Investment, Uncertainty

JEL Classification: D81