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A Markup Interpretation of Optimal Rules for Irreversible Investment

17 Pages Posted: 8 Jul 2000  

Avinash Dixit

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

Robert S. Pindyck

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Sigbjorn Sodal

Agder University College

Date Written: March 1997

Abstract

We re-examine the basic investment problem of deciding when to incur a sunk cost to obtain a stochastically fluctuating benefit. The optimal investment rule satisfies a trade-off between a larger versus a later net benefit; we show that this trade-off is closely analogous to the standard trade-off for the pricing decision of a firm that faces a downward sloping demand curve. We reinterpret the optimal investment rule as a markup formula involving an elasticity that has exactly the same form as the formula for a firm's optimal markup of price over marginal cost. This is illustrated with several examples.

Suggested Citation

Dixit, Avinash and Pindyck, Robert S. and Sodal, Sigbjorn, A Markup Interpretation of Optimal Rules for Irreversible Investment (March 1997). NBER Working Paper No. w5971. Available at SSRN: https://ssrn.com/abstract=225750

Avinash K. Dixit (Contact Author)

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States
609-258-4013 (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

Robert S. Pindyck

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

100 Main Street
Cambridge, MA 02139
United States
617-253-6641 (Phone)
617-258-6855 (Fax)

HOME PAGE: http://web.mit.edu/rpindyck/www/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Sigbjorn Sodal

Agder University College ( email )

Dept. of Economics
4601 Kristiansand
Norway

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