Lumpy Capacity Investment and Disinvestment Dynamics

Ulrich Doraszelski, Mark Satterthwaite, Lauren Xiaoyuan Lu and David Besanko
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Ulrich Doraszelski: Harvard University
Mark Satterthwaite: Northwestern University
Lauren Xiaoyuan Lu: University of North Carolina
David Besanko: Northwestern University

No 106, 2009 Meeting Papers from Society for Economic Dynamics

Abstract: Capacity addition and withdrawal decisions are among the most important strategic decisions made by firms in oligopolistic industries. In this paper, we develop and analyze a fully dynamic model of an oligopolistic industry with lumpy capacity and lumpy investment/disinvestment. We use our model to answer two questions. First, what economic factors facilitate preemption races? Second, what economic factors facilitate capacity coordination? We show that low product differentiation, low investment sunkness, and high depreciation promote preemption races. We also show that low product differentiation and low investment sunkness promote capacity coordination. Although depreciation removes capacity, it may impede capacity coordination. Finally, we show that, at least over some range of parameter values, firms' expectation plays a key role in determining whether or not industry dynamics are characterized by preemption races and capacity coordination. Taken together, our results suggest that preemption races and excess capacity in the short run often go hand-in-hand with capacity coordination in the long run.

Date: 2009
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