The Impact of Lead Time on Capital Investments

50 Pages Posted: 11 Jan 2019

See all articles by Talat Genc

Talat Genc

University of Guelph - Department of Economics

Date Written: January 1, 2017

Abstract

We study equilibrium investment strategies of firms competing in stochastic dynamic market settings and facing two types of investment structures: investment with significant lead time (or time-to-build) and investment without (or minor) lead time. We investigate how investment behavior changes when investment is subject to time-to-build versus when it is not. We characterize equilibrium investment strategies under several information structures and compare results to the social optimum. We offer some new results. The model predicts that, controlling for demand, and production and investment costs, investments and outputs can be higher in progressive industries (which often exhibit time-to-build) than in fast-paced industries (where time-to-build is insignificant). Furthermore, for both investment types (investment with or with- out time-to-build) we offer a novel equilibrium in which firms incrementally invest. This behavior is driven by demand uncertainty and capacity constraints. Also, expected outputs are lower than Cournot outputs as firms face uncertainty. Moreover, the amount of uncertainty has different effects over investment types.

Keywords: Capacity Investment; Capacity Constraints; Progressive Industry; Fast-Paced Industry; Demand Uncertainty; Time-to-Build; Markov Perfect Equilibrium; Open-Loop Equilibrium

JEL Classification: C73; D92; E22; G31

Suggested Citation

Genc, Talat, The Impact of Lead Time on Capital Investments (January 1, 2017). Available at SSRN: https://ssrn.com/abstract=3308841 or http://dx.doi.org/10.2139/ssrn.3308841

Talat Genc (Contact Author)

University of Guelph - Department of Economics ( email )

50 Stone Road East
Guelph, Ontario N1G 2W1
Canada

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