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A Producer Theory with Business Risks

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  • Seong-Hoon Kim
  • Seongman Moon

Abstract

In this paper, we consider a producer who faces uninsurable business risks due to incomplete spanning of asset markets over stochastic goods market outcomes, and examine how the presence of the uninsurable business risks affects the producer’s optimal pricing and production behaviours. Three key (inter-related) results we find are: (1) optimal prices in goods markets comprise ‘markup’ to the extent of market power and ‘premium’ by shadow price of the risks; (2) price inertia as we observe in data can be explained by a joint work of risk neutralization motive and marginal cost equalization condition; (3) the relative responsiveness of risk neutralization motive and marginal cost equalization at optimum is central to the cyclical variation of markups, providing a consistent explanation for procyclical and countercyclical movements. By these results, the proposed theory of producer leaves important implications both micro and macro, and both empirical and theoretical.

Suggested Citation

  • Seong-Hoon Kim & Seongman Moon, 2012. "A Producer Theory with Business Risks," CDMA Working Paper Series 201201, Centre for Dynamic Macroeconomic Analysis.
  • Handle: RePEc:san:cdmawp:1201
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    File URL: http://www.st-andrews.ac.uk/~wwwecon/CDMA/papers/wp1201.pdf
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    Keywords

    Uninsurable Business Risks; Markup; Risk Premium; Hedge and Offer; Price Inertia; Stochastic Dominance; Conditional Sales Ratio.;

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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