DEMAND UNCERTAINTY AND THE VALUE OF SUPPLY OPPORTUNITIES

The study considers the optimal timing of production decisions under d emand uncertainty. In accordance with the modern theory of irreversibl e investment, the problem is modelled as one of optimal stopping. By t aking an approach which is independent of dynamic programming and the smooth-fit principle, we derive explicitly both the value of the oppor tunity and the optimal-demand threshold. We prove that the optimal-dem and threshold can be attained at a point where the smooth-fit principl e is not valid. We also carry out the comparative static analysis of t he optimal variables and derive conditions under which production ince ntives are held constant. A consequence of this analysis is that along the iso-incentive curve inflationary policy must be counteracted with strict monetary policy.