Unit 7: Drivers of Flexibility, Video 3: Discount rate and Learning Promote

TL;DR

The discount rate is an important factor to consider when deciding between building large capacity plants or smaller units over time. Learning and competitive gaming also play a role in decision making.

Transcript

[SQUEAKING] [RUSTLING] [CLICKING] RICHARD DE NEUFVILLE: I want to tie all this in with the discount rate here. Now, when the demand for capacity is growing, say, for electricity, you have two choices. You can build a big plant now for many years ahead. But I'm going to, I'm going to build a plant for the next 20 years. My father had this experience... Read More

Key Insights

• 🇦🇪 Building large capacity plants for future demand may be cheaper per unit, but delaying investments and factoring in the discount rate can counterbalance this advantage.
• ⏳ Learning and technological improvements can lead to lower unit costs over time by repeating the same production processes.
• 💄 Competitive gaming involves making commitments in advance to signal dominance and deter competitors.

Questions & Answers

Q: What are the two choices for meeting growing capacity demand for electricity?

The two choices are building a big plant upfront for many years ahead or building small units over time as the market grows.

Q: How does the discount rate play a role in decision making for capacity investments?

The discount rate helps determine the present value of future investments and can counterbalance the advantages of economies of scale by discounting costs over time.

Q: How does learning affect unit costs?

Learning, or the production of more units, leads to lower unit costs as companies become more efficient in their production processes.

Q: What is competitive gaming in decision making?

Competitive gaming involves making a commitment in advance to signal to competitors and establish dominance in the market. It eliminates flexibility but can give a competitive advantage.

Summary & Key Takeaways

• Building a large capacity plant upfront is based on economies of scale, while building smaller units over time allows for flexibility in meeting market demand.

• Delaying investments and factoring in the discount rate can counterbalance the advantages of economies of scale.

• Learning, or the production of more units leading to lower unit costs, can make future investments cheaper.

• Competitive gaming, or making a commitment in advance, can signal to competitors and establish dominance.