A Producer Theory with Business Risks

Seong-Hoon Kim and Seongman Moon

No 2012-39, SIRE Discussion Papers from Scottish Institute for Research in Economics (SIRE)

Abstract: In this paper, we consider who faces uninsurable business risks due to incomplete spanning of asset markets over stochastic goods market outcomes, and examine how the presence of the uninsurable business risks affects the producer's optimal pricing and production behaviours. Three key (inter-related) results we find are: (1) optimal prices in goods markets comprise 'markup' to the extent of market power and 'premium' by shadow price of the risks; (2) price inertia as we observe in data can be explained by a joint work of the risk neutralization motive and marginal cost equalization condition; (3) the relative responsiveness of risk neutralization motive and marginal cost equalization at optimum is central to the cyclical variation of markups, providing a consistent explanation for procyclical and countercyclical movements. By these results, the proposed theory of producers leaves important implications both micro and macro, and both empirical and theoretical.

Keywords: uninsurable business risks; markup; risk premium; hedge and offer; price inertia; stochastic dominance; conditional sales ratio (search for similar items in EconPapers)
Date: 2012
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Persistent link: https://EconPapers.repec.org/RePEc:edn:sirdps:368

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