Lumpy Capacity Investment and Disinvestment Dynamics

Operations Research 58(4) 1178-1193, 2010

UNC Kenan-Flagler Research Paper

16 Pages Posted: 3 Feb 2013

See all articles by David Besanko

David Besanko

Northwestern University - Kellogg School of Management

Ulrich Doraszelski

Harvard University - Department of Economics; University of Pennsylvania - Business & Public Policy Department

Lauren Xiaoyuan Lu

University of North Carolina Kenan-Flagler Business School

Mark Satterthwaite

Northwestern University - Kellogg School of Management

Multiple version iconThere are 3 versions of this paper

Date Written: 2010

Abstract

Capacity addition and withdrawal decisions are among the most important strategic decisions made by fi…rms 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 suggest answers to two questions. First, what economic factors facilitate preemption races? Second, what economic factors facilitate capacity coordination? With a series of examples we show that low product differentiation, low investment sunkness, and high depreciation tend to promote preemption races. The same examples also show that low product differentiation and low investment sunkness tend to promote capacity coordination. Although depreciation removes capacity, it may impede capacity coordination. Finally, our examples show that multiple equilibria arise at least over some range of parameter values. The distinct structures of these equilibria suggest that fi…rms’ expectations play 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.

Keywords: capacity, investment and disinvestment, industry evolution, preemption races, capacity coordination, dynamic stochastic game, Markov perfect equilibrium

Suggested Citation

Besanko, David A. and Doraszelski, Ulrich and Lu, Lauren Xiaoyan and Satterthwaite, Mark A., Lumpy Capacity Investment and Disinvestment Dynamics (2010). Operations Research 58(4) 1178-1193, 2010; UNC Kenan-Flagler Research Paper. Available at SSRN: https://ssrn.com/abstract=2210598

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

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 Xiaoyan Lu (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

McColl Building, CB#3490
Chapel Hill, NC 27599
United States

HOME PAGE: http://public.kenan-flagler.unc.edu/faculty/lul/index.htm

Mark A. Satterthwaite

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

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