Capital accumulation, asset values and imperfect product market competition

We study the dynamics of an oligopolistic industry in which N firms produce a homogenous product and strategically invest in physical capital. Firms play a Markov game for which we derive equilibrium investment strategies. Since we assume nonlinear demand and cost structures, analytical results can only be found for a special case of our model. General insights into equilibrium investment strategies are derived through a numerical solution procedure. Using a projection method, we compute investment policy functions for different adjustment costs associated with capacity expansion. Equilibrium strategies are characterized by two distinct effects. First, there is a deterrence effect, i.e. firms decrease their investment levels with an increase in the rivals' capital stocks. Second, there is a preemptive role of capital. Firms overinvest and build up a large stock of capacity to deter the rival from expanding.