Optimizing Production under Uncertainty: Generalisation of the State-Contingent Approach and Comparison of Methods for Empirical Application
AbstractIn a recent paper Rasmussen (Rasmussen 2003) derived criteria for optimal production under uncertainty based on the state-contingent approach developed by Chambers and Quiggin (2000). While the criteria in the 2003-paper were derived for the one variable input case, and for different types of input, the present paper generalises the results to the multi-variable input case. It is further shown that with the output-cubical technology as the basic model, any type of input may be analysed as a special case within the general model framework developed. The main part of the paper is devoted to the problems of empirical application of the State-contingent approach. To empirically apply the optimization criteria derived, one needs specific functional forms of both the state-contingent production functions and the utility function based on state-contingent income measures. The paper shortly reviews the empirical approach normally taken when using the well-known Expected Utility (EU) model and this approach is in turn compared to the more general approach potentially available in the state-contingent model. Comparisons show that the potential benefit of the state-contingent approach compared to the expected utility model is limited by the empirical opportunities. Thus, it is unrealistic to expect production functions to be estimated for all possible states of nature. State-contingent production functions therefore, have to be considered as stochastic production functions. In this case, it is not obvious whether the state-contingent approach is better than the expected utility model, and it is proposed that this is further investigated using Monte-Carlo simulation.
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Bibliographic InfoPaper provided by Royal Veterinary and Agricultural University, Food and Resource Economic Institute in its series Unit of Economics Working papers with number 24184.
Date of creation: 2004
Date of revision:
Production Economics; Risk and Uncertainty;
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- Just, Richard E. & Pope, Rulon D., 1978. "Stochastic specification of production functions and economic implications," Journal of Econometrics, Elsevier, vol. 7(1), pages 67-86, February.
- Robert G. Chambers & John Quiggin, 2002. "The State-Contingent Properties of Stochastic Production Functions," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 84(2), pages 513-526.
- Quiggin, John, 2002. " Risk and Self-Protection: A State-Contingent View," Journal of Risk and Uncertainty, Springer, vol. 25(2), pages 133-45, September.
- C.J. O'Donnell & W.E. Griffiths, 2004.
"Estimating State-Contingent Production Frontiers,"
Department of Economics - Working Papers Series
911, The University of Melbourne.
- Adamson, David & Oss-Emer, Max & Quiggin, John, 2011. "Property Rights and Water Buy Back in Australia's Murray-Darling Basin," Risk and Sustainable Management Group Working Papers 149883, University of Queensland, School of Economics.
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