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The Mills model treats capital as malleable ; it assumes that, at the end of each time period, invested capital is recovered and then fully available for re-investment in some other best use the next time period. When we come to real estate and other fixed capital formation however, such malleability may not be present. If there is a resulting potential for loss should investors want or need to re-sell structures, fixtures , and other equipment at a future date, this risk presumably is incorporated into their decisions about the investment . In investment, there can be either upside risks (capital gains and other revenue) or downside risks (capital losses or other costs) and these may not be symmetric . In this chapter, I present a model of an export firm in a situation similar to that in Chap. 5. I assume that the firm must make a capital investment in advance (say for a building) but is uncertain as to the amount of labor that will be forthcoming to it. If the amount of labor forthcoming is low, the firm incurs the opportunity cost of the capital sitting unused. If the amount of labor forthcoming is high, the firm has the regret of not being able to earn still more profit. The model then predicts how much capital the firm commits as a function of the level of uncertainty about how much labor will be forthcoming. In general, the greater the uncertainty, the more the firm builds excess capacity. In turn, this implies “underused ” fixed capital might foster new industries that cannot afford to invest capital on their own.
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- Risk, Investment, and the Urban Economy
John R. Miron
- chapter 13