TY - JOUR
AU - Dixit,Avinash
AU - Pindyck,Robert S.
AU - Sodal,Sigbjorn
TI - A Markup Interpretation of Optimal Rules for Irreversible Investment
JF - National Bureau of Economic Research Working Paper Series
VL - No. 5971
PY - 1997
Y2 - March 1997
UR - http://www.nber.org/papers/w5971
L1 - http://www.nber.org/papers/w5971.pdf
N1 - Author contact info:
Avinash Dixit
Department of Economics
Princeton University
Princeton, NJ 08544-1017
E-Mail: dixitak@princeton.edu
Robert S. Pindyck
MIT Sloan School of Management
100 Main Street, E62-522
Cambridge, MA 02142
Tel: 617/253-6641
Fax: 617/258-6855
E-Mail: RPINDYCK@MIT.EDU
AB - We re-examine the basic investment problem of deciding when to incur a sunk cost to obtain a stochastically fluctuating benefit. The optimal investment rule satisfies a trade-off between a larger versus a later net benefit; we 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.
ER -