Expandability, reversibility, and optimal capacity choice
Author(s)Dixit, Avinash K.; Pindyck, Robert S.
Massachusetts Institute of Technology. Center for Energy and Environmental Policy Research.
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We develop continuous-time models of capacity choice when demand fluctuates stochastically, and the firm's opportunities to expand or contract are limited. Specifically, we consider costs of investing or disinvesting that vary with time, or with the amount of capacity already installed. The firm's limited opportunities to expand or contract create call and put options on incremental units of capital; we show how the values of these options affect the firm's investment decisions.
MIT Center for Energy and Environmental Policy Research
MIT-CEEPR (Series) ; 97-006WP.