Cost uncertainty and the rate of investment

Abstract

This paper examines the effect of cost and price uncertainty on the optimal rate of investment by firms within a general equilibrium framework. Former works which have studied this issue like Hartman (1972) and Abel (1983, 1984, 1985) have come to the conclusion that this effect is positive, since increased price uncertainty raises expected profitability. But these studies assume a fixed discount rate, which is equivalent to assuming that consumers are risk-neutral. This paper shows that if consumers are risk-averse the effect of uncertainty may be reversed and investment may be depressed when price or cost uncertainty is increased.