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Price Uncertainty, The Competitive Firm and the Dual Theory of Choice Under Risk

Fanny Demers and Michel Demers ()

Carleton Industrial Organization Research Unit (CIORU) from Carleton University, Department of Economics

Abstract: This paper undertakes an analysis of the competitive firm facing output price uncertainty based on Yaari's dual theory of choice under risk. The axiomatic foundation of Yaari's non-expected utility approach permits the formulation of a preference functional which is linear in profit but non-linear in distribution. Yaari's approach allows seperation of the firm's attitude towards risk from its attitude towards wealth and is consistent with experimental evidence on decision-making under uncertainty. In Yaar's dual theory the linearity in profit of the preference funcional stems from a constant marginal utility of wealth and is compatible with either risk aversion or risk inclination. This appealing feature of the dual theory allows us (1) to obtain a characterization of output and input decisions of firms which , unlike the von Neumann-Morgenstern theory of the firm, is in comformity with the main results of the theory of the firm under certainty; (2) to find intuitive comparative statistics effects of increases in risk and risk aversion; (3) to define the profit function for a firm with dual theoretic preferences and show how Hotelling's lemma can be applied to find the firm's output supply and input demand functions.

Keywords: theory of the firm; risk; risk aversion; increase in risk; non-expected utility model; duality and the profit function. (search for similar items in EconPapers)
Pages: 31 pages
Date: 1989
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Citations: View citations in EconPapers (3)

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