Timing of Investment and Dynamic Pricing in Privatized Sectors

In equipment-intensive sectors - such as water utilities, power generation, gas - billions of dollars are spent in capital equipment. We discuss and characterize the optimal policy of a profit-maximizing firm and compare it with the optimal policy of a welfare-maximizing planner. When there is no technical progress, the duration of the plant is longer for a private firm. With technical progress, we show that duration tends to increase when the installed capacity increases over time, while it tends to decrease when technical progress reduces operating costs. Under some conditions we also show that when capacity expands over time the duration of the plant is shorter for a public firm than for a private firm.