The Mix and Scale of Factors with Irreversibility and Fixed Costs of Investment

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When factors of production can be adjusted costlessly, the mix of factors can be considered separately from their scale. We examine factor choice and utilization when investment is irreversible and subject to a fixed cost, so that the capital stock is a quasi-fixed factor that is adjusted infrequently and by discrete amounts. We derive and analyze analytic approximations for optimal investment behavior, and show how the quasi-fixity of capital eliminates the dichotomy between factor mix and scale. We show that the quasi-fixity of capital can give rise to labor hoarding, even when labor is a purely flexible factor.

Published: Carnegic-Rochester Conference Series on Public Policy, June 1998, Vol. 48, no. 1: 101-135

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