Demand Uncertainty, Capital Specificity, and Industry Evolution

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Abstract
The existence of capital that is specific to an industry (its investment cost exceeds its value-in-use in other industries) radically alters the equilibrium in an otherwise straight-forward neoclassical model. In particular, as demand ofalls exit is impeded and as demand rises the entry of new capital is also impeded in the sense that a positive rate of profit at a given point in time need not induce investment. This paper investigates the interplay between capital mobility, demand uncertainty, industry investment, and price. In particular, the existence and uniqueness of a competitive equilibrium in a stationary environment is established. The equilibrium is fully characterized by two thresholds L≤H: entry occurs when the ratio of intrinsic demand to capital is above H and exit occurs when this ratio is below L. Whether or not exit is reversible (it is not when the act of exit renders the capital unsuitable for future use in the industry), equilibrium demands that L increase and H decrease with mobility.

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