The Effect of Cost Asymmetry and Output Flexibility on Capacity Choices

35 Pages Posted: 4 Apr 2013 Last revised: 17 Apr 2019

See all articles by Benoit Chevalier-Roignant

Benoit Chevalier-Roignant

Cranfield School of Management

Christoph Flath

University of Wuerzburg

Peter M. Kort

Tilburg University - Department of Econometrics & Operations Research; Tilburg University - Center for Economic Research (CentER)

Lenos Trigeorgis

University of Cyprus - Department of Public and Business Administration; King's College London; Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: April 15, 2019

Abstract

Strategic interactions are part of business life. We model a situation where several firms may enter the market at a future time and compete with invested rivals in quantity. In the second-stage dynamic Cournot model, firms have operational flexibility to set output in the face of competition given stochastic demand and capacity constraints. Owing to capacity constraints, the firm cannot fully tap on increased demand, with the value of a firm growing at a lower rate once the upper capacity constraint becomes binding. Earlier entry decisions may give rise to a coordination problem among would-be entrants. We characterize the Markov Perfect Equilibria (MPE) and obtain the value of the investment option in the most likely MPE. The value of the investment option is not necessarily monotone increasing and convex under competition but rather it exhibits "competitive waves."

Keywords: Operational flexibility, real options, market entry, industrial organization

Suggested Citation

Chevalier-Roignant, Benoit and Flath, Christoph and Kort, Peter and Trigeorgis, Lenos, The Effect of Cost Asymmetry and Output Flexibility on Capacity Choices (April 15, 2019). Available at SSRN: https://ssrn.com/abstract=2244231 or http://dx.doi.org/10.2139/ssrn.2244231

Benoit Chevalier-Roignant (Contact Author)

Cranfield School of Management ( email )

Cranfield
Bedfordshire MK43 OAL, MK43 0AL
United Kingdom

Christoph Flath

University of Wuerzburg

Law Faculty
Domerschulstra├če 16
W├╝rzburg, DE Bavaria D-97070
Germany

Peter Kort

Tilburg University - Department of Econometrics & Operations Research ( email )

Tilburg, 5000 LE
Netherlands
+31 13 466 2062 (Phone)
+31 13 466 3072 (Fax)

HOME PAGE: http://center.uvt.nl/staff/kort/

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2062 (Phone)
+31 13 466 3072 (Fax)

Lenos Trigeorgis

University of Cyprus - Department of Public and Business Administration ( email )

75 Kallipoleos Street
P.O. Box 20537
Nicosia CY-1678
Cyprus
00357 2 338762 (Phone)
00357 2 339063 (Fax)

King's College London ( email )

Strand
London, WC2R 2LS
United Kingdom

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

77 Massachusetts Ave. E62-663
Cambridge, MA 02142
United States

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