Optimal Investment with Costly Reversibility

Andrew B. Abel, Janice C. Eberly

NBER Working Paper No. 5091
Issued in April 1995
NBER Program(s):   EFG

Investment is characterized by costly reversibility when a firm can purchase capital at a given price and sell capital at a lower price. We derive an explicit analytic solution for optimal investment by a firm facing costly reversibility. In addition, we derive a local approximation to the solution which highlights the effects of the parameters of the problem on the triggers for investment. More generally, we extend the Jorgensonian concept of the user cost of capital to the case of uncertainty and define cU and cL as the user costs of capital associated with the purchase and sale of capital, respectively. Optimality requires the" firm to purchase and sell capital as needed to keep the marginal revenue product of capital in" the closed interval [cU,cL]. This prescription encompasses the case of irreversible investment as well as the standard" neoclassical case of costlessly reversible investment. Finally, quantitative analysis suggests" that even when the difference between the purchase and sale prices of capital is small user costs associated with purchasing and selling capital are closer to those applicable under" complete irreversibility than to those applicable under costless reversibility."

download in pdf format
   (531 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w5091

Published: Review of Economic Studies, vol.63, no.4, pp.581-593, August 1996. citation courtesy of

Users who downloaded this paper also downloaded* these:
Abel and Eberly w4296 A Unified Model of Investment Under Uncertainty
Abel and Eberly w5363 The Effects of Irreversibility and Uncertainty on Capital Accumulation
Bertola and Caballero w3865 Irreversibility and Aggregate Investment
Pindyck w1980 Irreversible Investment, Capacity Choice, and the Value of the Firm
Abel and Eberly w6148 The Mix and Scale of Factors with Irreversibility and Fixed Costs of Investment
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us