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Abstract

This paper explores how Knightian uncertainty affects dynamic properties in a model of economic growth. The decision-making theory in the analysis is that of expected utility under a non-additive probability measure, that is, the Choquet expected utility model of preference. We apply this decision theory to an overlapping-generations model where producers face uncertainty in their technologies. When the producer has aversion to uncertainty, the firm's profit function may not be differentiable. The firm's decision to invest and hire labor therefore becomes rigid for some measurable rage of real interest rate. In the dynamic equilibrium, the existence of the firm level rigidity causes discontinuity in the wage function, which makes multiple equilibria more likely outcome under log utility and Cobb-Douglass production functions. We show that even if aversion to uncertainty is small, "poverty trap" can arise for a wide range of parameter values.

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File URL: http://www.cirje.e.u-tokyo.ac.jp/research/dp/2007/2007cf502.pdf
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Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-502.

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Length: 29 pages
Date of creation: Jul 2007
Date of revision:
Handle: RePEc:tky:fseres:2007cf502

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Find related papers by JEL classification:

• D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
• D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Financing, Investment, and Capacity
• E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity

This paper has been announced in the following NEP Reports:

• NEP-ALL-2007-08-08 (All new papers)
• NEP-UPT-2007-08-08 (Utility Models & Prospect Theory)

References

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Cited by:

1. Shin-ichi Fukuda, 2012. "Infrequent Changes of the Policy Target: Robust Optimal Monetary Policy under Ambiguity," CARF F-Series CARF-F-295, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
2. Shin-ichi Fukuda, 2012. "Infrequent Changes of the Policy Target: Robust Optimal Monetary Policy under Ambiguity," CIRJE F-Series CIRJE-F-863, CIRJE, Faculty of Economics, University of Tokyo.
3. Eisei Ohtaki & Hiroyuki Ozaki, 2013. "Monetary Equilibria and Knightian Uncertainty," Keio/Kyoto Joint Global COE Discussion Paper Series 2012-032, Keio/Kyoto Joint Global COE Program.

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