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The authors set up a duopoly model with dynamic capacity constraints under demand uncertainty. They endogenize the investment decisions of the firms, examine their intertemporal pricing behavior, their incentives to merge, as well as the welfare implications of a merger. Whereas under known and constant demand the high capacity firm lets its low capacity rival sell out, under demand uncertainty they obtain a rich set of sales patterns. Each unit of available capacity has an option value (or opportunity cost), which depends on firms' capacities, the current demand and the remaining horizon. This option value may be higher when the firms act non-cooperatively compared to the case when they merge to form a monopoly.
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