Investment under Uncertainty and the Recipient of the Entry Cost

Abstract

A typical model of investment under uncertainty where firms incur an irreversible cost in order to produce is studied with a novel focus on the reciever of this cost ("the source"). The source is modeled as a firm or a government that sells a resource or a right that are necessary for the production of the final good. We study in detail how the source sets its resource's price. We find that this price is a decreasing function of the elasticity of the demand for the final good. We also find that when this demand is sufficiently low, the source does not lower its price accordingly, and the producers of the final good delay their purchases of the resource. The reason is that the source expects demand to be higher in the future and does not want to be committed then to a low price for its resource.