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On the Microeconomics of Diversification under Uncertainty and Learning

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Author Info
Chavas, Jean-Paul (U of Wisconsin)
Barham, Bradford

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Abstract

This paper investigates the microeconomics of diversification, based on a two-period model of an owner-managed firm facing uncertainty. The analysis utilizes a general state-contingent representation of uncertainty and learning. Economies of diversification are defined based on a certainty equivalent, which has three components: expected profit, the risk premium (measuring the cost of risk aversion), and the value of information associated with learning. The influence of scale effects, "trans-ray concavity" effects, and income effects on economies of diversification are examined in detail. We argue that, while scope economies and risk aversion can provide general incentives for diversification, information and learning can have the opposite effect. By integrating scope, risk, and the role of information, our analysis provides new insights on existing economic tradeoffs between firm diversification and specialization.

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Paper provided by University of Wisconsin, Agricultural and Applied Economics in its series Staff Paper Series with number 515.

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Date of creation: Oct 2007
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Handle: RePEc:ecl:wisagr:515

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D21 - Microeconomics - - Production and Organizations - - - Firm Behavior

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  1. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December. [Downloadable!] (restricted)
  2. Banerjee, Abhijit V & Newman, Andrew F, 1994. "Poverty, Incentives, and Development," American Economic Review, American Economic Association, vol. 84(2), pages 211-15, May. [Downloadable!] (restricted)
  3. repec:cup:cbooks:9780521622448 is not listed on IDEAS
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