On the Microeconomics of Diversification under Uncertainty and Learning

Jean-Paul Chavas () and Bradford Barham

Staff Paper Series from University of Wisconsin, Agricultural and Applied Economics

Abstract: This paper investigates the microeconomics of diversification, based on a two-period model of an owner-managed firm facing uncertainty. The analysis utilizes a general state-contingent representation of uncertainty and learning. Economies of diversification are defined based on a certainty equivalent, which has three components: expected profit, the risk premium (measuring the cost of risk aversion), and the value of information associated with learning. The influence of scale effects, "trans-ray concavity" effects, and income effects on economies of diversification are examined in detail. We argue that, while scope economies and risk aversion can provide general incentives for diversification, information and learning can have the opposite effect. By integrating scope, risk, and the role of information, our analysis provides new insights on existing economic tradeoffs between firm diversification and specialization.

JEL-codes: D21 (search for similar items in EconPapers)
Date: 2007-10
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Persistent link: http://EconPapers.repec.org/RePEc:ecl:wisagr:515

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