Irreversible Investment with Price Ceilings

Avinash Dixit

Journal of Political Economy, 1991, vol. 99, issue 3, 541-57

Abstract: A model of irreversible investment in a competitive industry under demand uncertainty is developed. In the absence of restrictions, investment by itself will keep the price from rising above a natural ceiling that exceeds the long-run average cost by an option value factor. When a lower ceiling is imposed, investment is triggered only by the observation of an even higher "shadow" price. As the imposed ceiling is reduced to the long-run average cost, this shadow price goes to infinity and investment ceases completely. Because investment is depressed, a tighter price ceiling generally leads to a higher long-run average price. Copyright 1991 by University of Chicago Press.

Date: 1991
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