A Model of Sequential Investment

This paper specifies a model of a two-stage sequential investment where the stages take time to complete. It presents algebraic solutions for an individual firm's optimal sequential investment with costless suspension, without suspension, in the intermediate case of costly suspension, and for aggregate investment. With suspension, the first-stage trigger is below the second-stage trigger for sufficiently long lags and high levels of output price uncertainty. Thus, the firm may carry out "exploratory" investment. We also evaluate the comparative statics of investment, and show how the patterns of project costs and lags affect the incentive to invest.

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