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The Choice Between Multiplicative and Additive Output Uncertainty

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  • Moavia Alghalith
  • Aredishir J. Dalal

Abstract

When modeling output uncertainty, the multiplicative specification is consistently chosen over the additive form, despite the latter being arguably intuitively more obvious. The rationale for this seems to be that when production risk is the only source of uncertainty, additive uncertainty does not reduce output below the certainty level, while multiplicative uncertainty does. We show that, regardless of the specification of output uncertainty, if hedging is absent and there is simultaneous price and output uncertainty, output is always lower than the situation in which one or both sources of uncertainty are absent. Thus, both models yield qualitatively identical results, i.e., adding a source of uncertainty reduces expected output. Therefore, additive uncertainty is indeed a reasonable a priori method of modeling production uncertainty

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Paper provided by Centre for Research into Industry, Enterprise, Finance and the Firm in its series CRIEFF Discussion Papers with number 0209.

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Date of creation: Feb 2002
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Handle: RePEc:san:crieff:0209

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Keywords: Multiplicative output uncertainty; additive output uncertainty; price uncertainty;

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  1. Lapan, Harvey E. & Moschini, GianCarlo, 1994. "Futures Hedging Under Price, Basis and Production Risk," Staff General Research Papers 10041, Iowa State University, Department of Economics.
  2. Honda, Yuzo, 1983. "Production uncertainty and the input decision of the competitive firm facing the futures market," Economics Letters, Elsevier, vol. 11(1-2), pages 87-92.
  3. Britto, Ronald, 1980. "Resource Allocation in a Simple, Two-Sector Model with Production Risk," Economic Journal, Royal Economic Society, vol. 90(358), pages 363-70, June.
  4. Losq, Etienne, 1982. "Hedging with price and output uncertainty," Economics Letters, Elsevier, vol. 10(1-2), pages 65-70.
  5. Viaene, Jean-Marie & Zilcha, Itzhak, 1998. "The Behavior of Competitive Exporting Firms under Multiple Uncertainty," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 591-609, August.
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Cited by:
  1. Moawia Alghalith, 2005. "Input demand with cost uncertainty," International Economic Journal, Taylor & Francis Journals, vol. 19(1), pages 115-123.

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