Subsidized Capacity Investment Under Uncertainty

Abstract

This paper studies how the subsidy support, e.g. price support and reimbursed investment cost support, affects the investment decision of a monopoly firm under uncertainty and analyzes the implications for social welfare. The analytical results show that the unconditional, i.e., subsidy support that is introduced from the beginning, makes the firm invest earlier. Under a linear demand structure, the unconditional subsidy cannot align the firm's investment decision to the social optimal one. However, a conditional subsidy, i.e., subsidy support introduced at the social optimal investment threshold, can align the two decisions. For a non-linear demand structure, it is possible for the unconditional subsidy to make the firm invest according to the social optimum. When the investment decisions are aligned, the firm's investment leads to the first-best outcome.

A bi-level model for optimal capacity investment and subsidy design under risk aversion and uncertainty

“…Applications of real options models for capacity investment under uncertainty to the energy sector are presented in Fleten et al (2007) and Bøckman et al (2008), while policy-oriented applications are presented in Siddiqui and Fleten (2010), Boomsma et al (2012), Boomsma and Linnerud (2015), Chronopoulos et al (2016) and Wen et al (2017a). More recently, Bigerna et al (2019) develop a real options model for optimal capacity investment in RE under market demand uncertainty within the context of the Italian strategy for RE deployment under the EU policy.…”