Daniel Danau, Business School, Bournemouth University, Executive Business Centre, 89 Holdenhurst Road, Bournemouth, Dorset, BH8 8EB, UK (firstname.lastname@example.org).
Capacity Investment with Dynamic Operation and Intertemporal Budget Balance
Article first published online: 9 MAR 2011
© 2011 Wiley Periodicals, Inc.
Journal of Public Economic Theory
Volume 13, Issue 2, pages 217–253, April 2011
How to Cite
DANAU, D. (2011), Capacity Investment with Dynamic Operation and Intertemporal Budget Balance. Journal of Public Economic Theory, 13: 217–253. doi: 10.1111/j.1467-9779.2011.01499.x
I gratefully acknowledge useful comments from Alain Bonnafous, Avinash Dixit, David Gillen, Jean-Michel Josselin, Eric Maskin and André de Palma, and seminar participants at the Institute for Advanced Study in Princeton as well as from participants at the 10th Annual Real Options Conference (New York 2006) and the 21st EEA Annual Congress (Vienna 2006). I also thank the associate editor and especially an anonymous referee for providing suggestions that helped me improve the previous version significantly. Any remaining error is mine.
- Issue published online: 9 MAR 2011
- Article first published online: 9 MAR 2011
- Received November 25, 2008; Accepted January 15, 2010.
We characterize the optimal investment and production path in a project characterized by indivisible capacity and stochastic inverse demand curve. At first best (without budget requirements), the investment is made earlier the lower the price elasticity of demand, causing the trajectory of production to be below the trajectory of capacity. At second best (when the investor is required to break even), the investment delay is upward distorted, the distortion being larger the lower the price elasticity of demand. Moreover, in the particular case of constant elasticity demand, investment is delayed but production remains at its first-best level.