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Essays on capacity underutilization and demand driven business cycles

Sun, Tiancheng (2020) Essays on capacity underutilization and demand driven business cycles. PhD thesis, London School of Economics and Political Science.

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Identification Number: 10.21953/lse.00004195


In Chapter 1, I build a macroeconomic model that features chronic excess capacity. In my model, if one firm expands its capacity while other firms do not, it \steals" profitable demand from others. This capacity competition externality can cause an over-investment in capacity. I show that with the existence of chronic excess capacity, capital resources can be slack and consumption demand shocks can generate realistic business cycles. If consumption demand increases, more capacity will be utilized, heating up the capacity competition: firms invest with haste until the capacity utilization rate falls back to normal. If consumption demand decreases, more capacity will be left idle, cooling down the capacity competition: firms dis-invest with haste until the capacity utilization rate goes back to normal. In Chapter 2, I show that the above results cannot be obtained in models with efficient utilization of capital or capacity. In these models, there is no capacity competition externality. None of these models could feature chronic excess capacity nor capital resource slackness. Thus, the response of output to demand shocks is limited and it is difficult to obtain demand driven business cycles in these models. In Chapter 3, I study what kind of goods market structure features the capacity competition externality that can cause chronic excess capacity. The following assumptions are identified. First, if a firm expands its capacity while other firms do not, it can \steal" demand from others. Second, firms can charge a sufficiently high price to make a positive net profit. These two assumptions imply a negative capacity competition externality and are sufficient to cause long-term capacity underutilization at the firm-level. Third, if the invested capital has no positive externality that can potentially offset the negative externality, the capacity competition externality will be dominant and the economy will exhibit chronic excess capacity. I present several different ways to micro-found this kind of goods market structure, demonstrating the generality of the results obtained in the previous chapters.

Item Type: Thesis (PhD)
Additional Information: © 2020 Tiancheng Sun
Library of Congress subject classification: H Social Sciences > HB Economic Theory
H Social Sciences > HC Economic History and Conditions
H Social Sciences > HD Industries. Land use. Labor
Sets: Departments > Economics
Supervisor: Den Haan, Wouter J.

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