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Uncertainty, Investment, and Industry Evolution

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  • Ricardo J. Caballero
  • Robert S. Pindyck

Abstract

We study the effects of aggregate and idiosyncratic uncertainty on the entry of firms, total investment, and prices in a competitive industry with irreversible investment. We first use standard dynamic programming methods to determine firms' entry decisions, and we describe the resulting industry equilibrium and its characteristics, emphasizing the effects of different sources of uncertainty. We then show how the conditional distribution of prices can be used as an alternative means of determining and understanding the behavior of firms and the resulting industry equilibrium. Finally, we use four-digit U.S. manufacturing data to examine some implications of the model.

Suggested Citation

  • Ricardo J. Caballero & Robert S. Pindyck, 1992. "Uncertainty, Investment, and Industry Evolution," NBER Working Papers 4160, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:4160
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    References listed on IDEAS

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    1. Majd, Saman & Pindyck, Robert S., 1987. "Time to build, option value, and investment decisions," Journal of Financial Economics, Elsevier, vol. 18(1), pages 7-27, March.
    2. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-638, June.
    3. Pindyck, Robert S, 1991. "Irreversibility, Uncertainty, and Investment," Journal of Economic Literature, American Economic Association, vol. 29(3), pages 1110-1148, September.
    4. Guiseppe Bertola & Ricardo J. Caballero, 1994. "Irreversibility and Aggregate Investment," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 61(2), pages 223-246.
    5. Ben S. Bernanke, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 98(1), pages 85-106.
    6. Pindyck, Robert S, 1988. "Irreversible Investment, Capacity Choice, and the Value of the Firm," American Economic Review, American Economic Association, vol. 78(5), pages 969-985, December.
    7. Caballero, Ricardo J., 1999. "Aggregate investment," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 12, pages 813-862, Elsevier.
    8. Avinash Dixit, 1989. "Hysteresis, Import Penetration, and Exchange Rate Pass-Through," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 104(2), pages 205-228.
    9. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 101(4), pages 707-727.
    10. Hartman, Richard, 1972. "The effects of price and cost uncertainty on investment," Journal of Economic Theory, Elsevier, vol. 5(2), pages 258-266, October.
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    More about this item

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity

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