The Choice Between Multiplicative and Additive Output Uncertainty
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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- 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.
- Losq, Etienne, 1982. "Hedging with price and output uncertainty," Economics Letters, Elsevier, vol. 10(1-2), pages 65-70.
- 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.
- 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.
- 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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