NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The Effects of Irreversibility and Uncertainty on Capital Accumulation

Andrew B. Abel, Janice C. Eberly

NBER Working Paper No. 5363
Issued in November 1995
NBER Program(s):   AP   EFG   ME

When investment decisions cannot be reversed and returns to capital are uncertain, the firm faces a higher user cost of capital than if it could reverse its decisions. This higher user cost tends to reduce the firm's capital stock. Opposing this effect is the irreversibility constraint itself: when the constraint binds, the firm would like to sell capital but cannot. This effect tends to increase the firm's capital stock. We show that a firm with irreversible investment may have a higher or a lower expected capital stock, even in the long run, compared to an otherwise identical firm with reversible investment. Furthermore, an increase in uncertainty can either increase or decrease the expected long-run capital stock under irreversibility relative to that under reversibility. However, changes in the expected growth rate of demand, the interest rate, the capital share in output, and the price elasticity of demand all have unambiguous effects.

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Document Object Identifier (DOI): 10.3386/w5363

Published: Journal of Monetary Economics, Vol. 44, no. 3 (December 1999): 339-377. citation courtesy of

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