UNCERTAINTY, INVESTMENT, AND INDUSTRY EVOLUTION

We study the effects of industry-wide and idiosyncratic uncertainty on the entry of firms, total investment, and prices in a competitive ind ustry with irreversible investment. We determine entry decisions and t he resulting industry equilibrium and its characteristics, emphasizing effects of different sources of uncertainty. We stress how irreversib ility affects the equilibrium distribution of prices, which in turn af fects entry. Finally, we use four-digit U.S. manufacturing data to mea sure the extent of uncertainty and gauge its importance for investment . We find that a doubling of industry-wide uncertainty raises the requ ired rate of return on new capital by about 20 percent.