On optimal factor proportions in a competitive firm under factor and output price uncertainty
Most observers of economic events have noticed a considerable increase in the general volatility of prices over the last decade. An important byproduct often attributed to this increased price variability is greater uncertainty perceived by individual decisionmakers in the process of formulating intertemporal plans. This paper seeks to clarify and provide some extensions to previous theoretical work on the question of how economic agents adjust to increased price uncertainty in the context of the competitive firm. In particular, the question asked is whether the optimal choice of inputs in a competitive firm is affected by the advent of increased factor and output price uncertainty. The answer given in earlier studies such as those by Baron (1970), Batra and Ullah (1974), Leland (1972) and Sandmo (1971) is quite straightforward: If competitive-firm managers are risk-neutral profit maximizers, the optimal input mix remains unaffected by increased uncertainty, while under risk-averse managers, firms either reduce their scale of operations or adjust their input mix towards relatively greater use of less risky inputs.
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- Hartman, Richard, 1972. "The effects of price and cost uncertainty on investment," Journal of Economic Theory, Elsevier, vol. 5(2), pages 258-266, October.
- Dietrich, J Kimball & Heckerman, Donald G, 1980. "Uncertain Inflation and the Demand for Capital," Economic Inquiry, Western Economic Association International, vol. 18(3), pages 461-71, July.
- Baron, David P, 1970. "Price Uncertainty, Utility, and Industry Equilibrium in Pure Competition," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 11(3), pages 463-80, October.
- Martin Neil Baily, 1981. "Productivity and the Services of Capital and Labor," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1), pages 1-66.
- Batra, Raveendra N & Ullah, Aman, 1974. "Competitive Firm and the Theory of Input Demand under Price Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 82(3), pages 537-48, May/June.
- Hartman, Richard, 1976. "Factor Demand with Output Price Uncertainty," American Economic Review, American Economic Association, vol. 66(4), pages 675-81, September.
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