Market Growth, Economies of Scale, and Capacity Expansion in the Chemical Processing Industries

By Marvin B. Lieberman
1985| Working Paper No. 829

What factors determine the size of new industrial plants? This study uses data on 23 chemical products to test alternative models of capacity expansion, including: (1) the Manne model, which yields a constant cycle time between plant construction dates, so that new plant sizes are proportional to market growth, and (2) a “scale frontier” model in which shift over time as the result of technical progress. The empirical results strongly support the scale frontier model. The size of new plants increased along a time trend which was unrelated to market concentration, market growth, or the extent of estimated scale economies. Entrants typically built smaller plants than incumbents, but all firms built plants closer to the technological frontier when small plants carried a higher relative cost penalty. Although market growth had no effect on the size of new plants, it did influence the cycle time between plant expansions; more rapid growth induced firms to expand capacity more frequently, rather than in larger increments as predicted by the Manne model.