Investment, Capacity Constraints and Uncertainty on the Input Price

This paper extends the theory of irreversible investment under uncertainty to incorporate capacity constraints and uncertainty on the input price. In addition, no restriction on the demand elasticity value is imposed. Assuming input price follows a geometric Brownian motion, the optimal irreversible investment policy of a risk neutral regulated firm is analyzes. A simple rule that maximizes social welfare is derived and used to compute the optimal exercise rule, in several numerical simulations.