We develop continuous-time models of capacity choice when demand fluctuates stochastically, and the firm’s opportunities to expand or contract are […]
READ moreotherwise a second-best equilibrium is implemented. The latter is sensitive to uncertainty in control costs and benefits.
READ morewe 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.
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