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A Markup Interpretation of Optimal Rules for Irreversible Investment

Avinash Dixit (), Robert 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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Published as Dixit, Aumash, Robert S. Pindyck and Sighiorn Sodal. "A Markup Interpretation Of Optimal Investment Rules," Economic Journal, 1999, v109(455,Apr), 179-189.

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