Date of this Version
International Journal of Industrial Organization
Even mature industries seldom settle down into a long-run steady state. Fluctuations in demand disrupt the status quo and call for firms to adjust their capacities on an ongoing basis. We construct a fully dynamic model of an oligopolistic industry with lumpy capacity and lumpy investment/disinvestment decisions. In addition to uncertainty about the evolution of demand, a firm faces strategic uncertainty concerning the decisions of its rivals. We numerically solve the model for its Markov-perfect equilibria. For one set of parameter values, three equilibria exist, and while all of them have simple, intuitive structures, they exhibit widely varying patterns of response to demand shocks. At one extreme, one firm dominates the industry almost as a monopolist and changes its capacity to accommodate demand. At the other extreme, the larger firm keeps its capacity nearly constant while the smaller firm acts as the swing producer.
© <2010>. This manuscript version is made available under the CC-BY-NC-ND 4.0 license http://creativecommons.org/licenses/by-nc-nd/4.0/
capacity investment and disinvestment, demand uncertainty, strategic uncertainty, dynamic stochastic games, markov-perfect equilibrium
Besanko, D., Doraszelski, U., Xiaoyuan Lu, L., & Satterthwaite, M. A. (2010). On the Role of Demand and Strategic Uncertainty in Capacity Investment and Disinvestment Dynamics. International Journal of Industrial Organization, 28 (4), 383-389. http://dx.doi.org/10.1016/j.ijindorg.2010.02.013
Date Posted: 27 November 2017
This document has been peer reviewed.