On the Role of Demand and Strategic Uncertainty in Capacity Investment and Disinvestment Dynamics

International Journal of Industrial Organization 28(4) 383-389, 2010

7 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

Date Written: 2010

Abstract

Even mature industries seldom settle down into a long-run steady state. Fluctuations in demand disrupt the status quo and call for firms to adjust their capacities on an ongoing basis. We construct a fully dynamic model of an oligopolistic industry with lumpy capacity and lumpy investment/disinvestment decisions. In addition to uncertainty about the evolution of demand, a firm faces strategic uncertainty concerning the decisions of its rivals. We numerically solve the model for its Markov-perfect equilibria. For one set of parameter values, three equilibria exist, and while all of them have simple, intuitive structures, they exhibit widely varying patterns of response to demand shocks. At one extreme, one firm dominates the industry almost as a monopolist and changes its capacity to accommodate demand. At the other extreme, the larger firm keeps its capacity nearly constant while the smaller firm acts as the swing producer.

Keywords: Capacity investment and disinvestment, Demand uncertainty, Strategic uncertainty, Dynamic stochastic games, Markov-perfect equilibrium

JEL Classification: L11, L13, E22, C73

Suggested Citation

Besanko, David A. and Doraszelski, Ulrich and Lu, Lauren Xiaoyan and Satterthwaite, Mark A., On the Role of Demand and Strategic Uncertainty in Capacity Investment and Disinvestment Dynamics (2010). International Journal of Industrial Organization 28(4) 383-389, 2010. Available at SSRN: https://ssrn.com/abstract=2210668

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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