We found a match
Your institution may have access to this item. Find your institution then sign in to continue.
- Title
Uncertainty and Lags in the Investment Decisions of Firms.
- Authors
Nickell, Stephen
- Abstract
As is well known from the work of Arrow on myopic decision rules, a firm's optimal investment policy is completely unaffected by the introduction of uncertainty if the firm can adjust its capital stock freely and instantaneously at every point in time. This is hardly a surprising result since the firm's capital stock decision at any instant is quite independent of decisions made at any other instant. It is also most unappealing as a description of reality since both casual observation and relevant econometric work indicate that the investment response of firms, both to current and future expected parametric changes, is not an immediate jump to a new "optimal" level of capital stock but is sluggish and distributed over a considerable period. One of the most popular methods of rationalizing such a distributed lag response is to posit so-called "costs of adjustment" which are costs over and above the purchase price associated with the acquisition and installation of new capital goods. Such costs are assumed to be a function either of the rate of gross or net investment and are justified by reference to the costs of disruption, the training of workers, management problems and the like. Unfortunately in order for such costs to yield the sort of distributed lag adjustment which they purport to rationalize, they must be strictly convex in either gross or net investment, an assumption which is extremely difficult to justify on prior grounds. Indeed, as is pointed out in Rothschild, given the fixity of some of the costs involved, the indivisibilities in the technology of training and similar considerations, it is far more likely that these costs are strictly concave for a considerable range of investment rates and there seems no particular reason why they should ever become strictly convex. In this case the optimal capital policy for the firm involves just the sort of instantaneous jumps in capital stock which the adjustment cost assumption was supposed to remove. In general, then, we may argue that the assumption of strictly convex adjustment costs, though extremely convenient analytically, is really a simple mechanistic device for obtaining reasonable investment paths from the profit-maximizing activities of firms rather than a realistic attempt to analyse the investment decision.
- Subjects
BUSINESS enterprises; INVESTMENTS; CAPITAL; UNCERTAINTY; CAPITAL stock; DECISION making; ECONOMETRIC models; ECONOMICS; STOCKS (Finance)
- Publication
Review of Economic Studies, 1977, Vol 44, Issue 2, p249
- ISSN
0034-6527
- Publication type
Article
- DOI
10.2307/2297065