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Irreversible investment with uncertainty and scale economies

Dixit, Avinash (1992) Irreversible investment with uncertainty and scale economies. TE, 240. Suntory and Toyota International Centres for Economics and Political Science, London School of Economics and Political Science, London, UK.

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Identification Number: 240

Abstract

This paper analyses optimal irreversible investment policy when profits are subject to a multiplicative geometric Brownian motion shock. The marginal product of capital is increasing initially and decreasing thereafter. In the latter range, optimal policy is familiar: capacity is added gradually as the shock rises to a threshold where the expected return on the marginal unit is a required multiple of the cost of capital. The multiple reflects the option value of waiting. The optimal policy in the increasing marginal product range obeys the same multiple, now applied to the total return on the discrete increase in capital. Implications for economic growth, and suboptimal equilibria under external economies, are examined.

Item Type: Monograph (Discussion Paper)
Official URL: http://sticerd.lse.ac.uk
Additional Information: © 1992 Avinash Dixit
Subjects: H Social Sciences > HG Finance
Sets: Collections > Economists Online
Research centres and groups > Suntory and Toyota International Centres for Economics and Related Disciplines (STICERD)
Date Deposited: 14 Jul 2008 11:51
Last Modified: 01 Oct 2010 09:11
URI: http://eprints.lse.ac.uk/id/eprint/19372

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