Irreversible Investment With Embodied Technological Progress
Bruno de Oliveira Cruz
In this paper, we propose to explain capital accumulation in a stochasticframework by taking into account the two main motives for investment. Specifically,firms invest to expand capacity and to replace old machines. The model considersirreversible investment under uncertainty and embodied technological progress. It isshown to be consistent with the following empirical observations: Investment islumpy and infrequent at the firm level; firms can invest even if they have not reachedfull capacity and technological progress is largely investment specific. We extend thepaper of Pindyck (1988), by introducing embodied technological progress. Toproduce firms use irreversible capital, perfectly flexible labor, and energy whose priceis stochastic. Capital and energy are complementary. We show that uncertaintymakes firms to postpone investment, increasing the age of the oldest machine andreducing the proportion of new machines in the total stock of capital. We provide anexercise with tax credit to acquire new machines; it is shown that under thehypothesis of embodiment and uncertainty, the tax credit is not effective.
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