The Impact of Lead Time on Capital Investments
50 Pages Posted: 11 Jan 2019
Date Written: January 1, 2017
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: Suggested Citation