The Effects of Irreversibility and Uncertainty on Capital Accumulation

Andrew Abel () and Janice Eberly ()

No 5363, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: When investment decisions cannot be reversed and returns to capital are uncertain, the firm faces a higher user cost of capital than if it could reverse its decisions. This higher user cost tends to reduce the firm's capital stock. Opposing this effect is the irreversibility constraint itself: when the constraint binds, the firm would like to sell capital but cannot. This effect tends to increase the firm's capital stock. We show that a firm with irreversible investment may have a higher or a lower expected capital stock, even in the long run, compared to an otherwise identical firm with reversible investment. Furthermore, an increase in uncertainty can either increase or decrease the expected long-run capital stock under irreversibility relative to that under reversibility. However, changes in the expected growth rate of demand, the interest rate, the capital share in output, and the price elasticity of demand all have unambiguous effects.

JEL-codes: E22 (search for similar items in EconPapers)
Date: Written 1995-11
Note: AP EFG ME
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Published as Journal of Monetary Economics, Vol. 44, no. 3 (December 1999): 339-377.

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Related works:
Working Paper: The Effects of Irreversibility and Uncertainty on Capital Accumulation
Journal Article: The effects of irreversibility and uncertainty on capital accumulation (1999)
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