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Production as behavior toward risk

Published online by Cambridge University Press:  17 August 2016

G.A. Hawawini  and
P.A. Michel
G.A. Hawawini
Affiliation:
INSEAD, France
P.A. Michel
Affiliation:
University of Liège
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Extract

Recent contributions to the theory of the firm have recognized the impact of uncertainty on both the firm’s behavior and its equilibrium position. Models were developed by Baron (1970, 1971), Sandmo (1971) and Leland (1972) that explicitly incorporate a random output price as well as the firm’s attitude toward the risk associated with production under price uncertainty. These models assume that, in the absence of complete foresight, the firm seeks to maximize the expected utility of its profits, in contrast to the traditional profit-maximizing firm operating under certainty. It is then shown that a firm which displays aversion toward risky activities will produce a smaller output under price uncertainty than under certainty, and that, contrary to the firm operating in a certain world, the risk averse firm may alter its optimal level of production in response to a change in its fixed costs.

These and other comparative-statics results derived by Baron, Sandmo and Leland are based on the general principle of expected utility maximization, first developed by Arrow (1965) in his work on the theory of risk aversion. An alternative approach is based on the mean-standard deviation framework (M-SD hereafter) developed by Markowitz (1952, 1959) and extended by Tobin (1958, 1965).

Type
Research Article
Information
Recherches Économiques de Louvain/ Louvain Economic Review , Volume 45 , Issue 3 , September 1979 , pp. 299 - 311
Copyright
Copyright © Université catholique de Louvain, Institut de recherches économiques et sociales 1979 

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References

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