ADJUSTMENT TO PRODUCTION UNCERTAINTY AND THE THEORY OF THE FIRM

Abstract

This paper considers the behavior of the firm which faces uncertainty in its production process but can adjust its output once the uncertainty is resolved. Ex post adjustment, unlike previous treatments, involves a marginal cost penalty if more output is required and a lowering of price if too much is produced. With ex post adjustment allowed in this fashion, it is found that nonlinear risk preferences do not affect the sign of the firm's marginal risk premium at optimum ex ante output. The firm will produce less output than under certainty whether it is risk averse, risk neutral, or prefers risk.