Demand Uncertainty Effect on Flexibility & Capacity

Nowadays firms often face high demand uncertainty. This uncertainty influences the desirability to invest in production capacity, the choice of the capacity level, and it raises the value of being able to adapt the production decision. In order to cope with unpredictable changes in demand, the firm needs to possess some degrees of flexibility in order to stay competitive and profitable.

Uncertainty is present in the sense that the future demand level is unknown and dynamics are taken into account by adopting a continuous time framework. Before the firm is able to produce goods, it has to install capacity. In deciding about capacity investment, the firm has to choose the timing as well as the capacity level. Once the cap