Working Paper: NBER ID: w4160
Authors: 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.
Keywords: Uncertainty; Investment; Industry Evolution; Dynamic Programming
JEL Codes: D92; E22; L11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Aggregate uncertainty (E10) | Firm entry (L26) |
| Aggregate uncertainty (E10) | Opportunity cost of investment (G31) |
| Opportunity cost of investment (G31) | Firm entry (L26) |
| Idiosyncratic uncertainty (D89) | Individual investment decisions (G11) |
| Aggregate uncertainty (E10) | Distribution of future marginal revenue products (D39) |
| Distribution of future marginal revenue products (D39) | Investment (G31) |