The Capacity Decision When Product Demand is Uncertain: A Timing Problem Approach

Abstract

Suppose a firm faces a "timing problem" in its capacity decision: it must acquire capacity, a strict upper bound on production, and set its price before quantity demanded for its product is known. The paper shows that the uncertainty capacity is greater than the certainty capacity when the marginal cost of capacity is low; the reverse holds for high marginal costs. Although there is a systematic relationship between the certainty and uncertainty prices, such differences are small. Therefore, our results suggest that the primary effect ofdemand uncertainty is on the firm 1s optimal capacity, rather than oti its optimal price. (D24, D8 l)