Capacity, volume flexibility, and costs

Anzhou Zhang

International Journal of Industrial Organization, 2024, vol. 97, issue C

Abstract: This paper studies strategic firms' capacity choices in the presence of demand uncertainty and imperfect downside and upside volume flexibility. It provides conditions under which firms' capacity is greater or less than their expected output. It shows under certain conditions, a first-order stochastically dominant demand distribution induces higher capacity, while a mean-preserving spread of a demand distribution induces lower capacity. By endogenizing volume flexibility, it shows that firms' downside flexibility tends to be lower than their upside flexibility. This implies a firm's short-run average cost tends to be asymmetrically U-shaped, namely, the average cost increases more when output falls below capacity (the efficient scale) than when output rises above capacity by an equivalent amount.

Keywords: Adjustment costs; Capacity investment; Volume flexibility (search for similar items in EconPapers)
JEL-codes: D24 L11 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:indorg:v:97:y:2024:i:c:s0167718724000511

DOI: 10.1016/j.ijindorg.2024.103096

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