Lumpy Capacity Investment and Disinvestment Dynamics

Capacity addition and withdrawal decisions are among the most important strategic decisions made by firms in oligopolistic industries. In this paper, we develop and analyze a fully dynamic model of an oligopolistic industry with lumpy capacity and lumpy investment/disinvestment. We use our model to suggest answers to two questions: First, what economic factors facilitate preemption races? Second, what economic factors facilitate capacity coordination? With a series of examples we show that low product differentiation, low investment sunkness, and high depreciation tend to promote preemption races. The same examples also show that low product differentiation and low investment sunkness tend to promote capacity coordination. Although depreciation removes capacity, it might impede capacity coordination. Finally, our examples show that multiple equilibria arise over at least some range of parameter values. The distinct structures of these equilibria suggest that firms' expectations play a key role in determining whether or not industry dynamics are characterized by preemption races and capacity coordination. Taken together, our results suggest that preemption races and excess capacity in the short run often go hand-in-hand with capacity coordination in the long run.