DP6788 | Lumpy Capacity Investment and Disinvestment Dynamics

Publication Date

23/04/2008

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Abstract

Capacity addition and withdrawal decisions are among the most important strategic decisions made by firms in oligopolistic industries. In this paper, we develop and analyze a fully dynamic model of an oligopolistic industry with lumpy capacity and lumpy investment/disinvestment. We use our model to answer two questions. First, what economic factors facilitate preemption races? Second, what economic factors facilitate capacity coordination? We show that low product differentiation, low investment sunkness, and high depreciation promote preemption races. We also show that low product differentiation and low investment sunkness promote capacity coordination. Although depreciation removes capacity, it may impede capacity coordination. Finally, we show that, at least over some range of parameter values, firms' expectation plays a key role in determining whether or not industry dynamics are characterized by preemption races and capacity coordination. Taken together, our results suggest that preemption races and excess capacity in the short run often go hand-in-hand with capacity coordination in the long run.