A Markup Interpretation of Optimal Rules for Irreversible Investment

Avinash Kamalakar Dixit (), Robert S. Pindyck () and Sigbjorn Sodal

No 5971, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: D92 D81 (search for similar items in EconPapers)
Date: 1997-03
Note: IO PR
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Working Paper: A markup interpretation of optimal rules for irreversible investment (1997)
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