UNCERTAINTY AND THE PRODUCTION DECISIONS OF OWNER-MANAGED AND LABOR-MANAGED FIRMS

Abstract

OVER the last decade several papers have examined the effects of output price uncertainty on the production decision of firms. One of the earliest contributions in this area was by Sandmo (1971). He and others have shown that the level of output of an owner-managed (O-M) firm producing under perfect competition and facing price uncertainty depends on the owner's attitude toward risk.' The risk-averse O-M firm produces less than the risk-neutral O-M firm which, in turn, produces less than the riskseeking O-M firm. Sandmo and others define certainty to be a situation in which the firm faces the mean of the probability distribution of output prices with certainty. In other words, the certain price is defined as the mean price. In this context, the level of output under price certainty equals the level of output that would be produced under price uncertainty and risk neutrality. Consequently, Sandmo's conclusion can be restated as follows: the riskaverse O-M firm produces a smaller output under price uncertainty than under price certainty and the risk seeking O-M firm produces a larger output under price uncertainty than under price certainty. In this paper I will argue that the definition of certainty adopted by Sandmo and other students of the theory of the firm under price uncertainty is arbitrary. An alternative and more realistic definition of certainty is suggested which modifies some of the standard conclusions regarding the production decision of firms under price uncertainty. Specifically, I show that: (1) when the O-M firm is risk neutral, the certainty output is no longer equal to the output produced under price uncertainty. In this case the risk-neutral O-M firm will produce a larger output under price uncertainty than under price certainty; (2) the behavior of the risk averse O-M firm facing uncertain demand is no longer unambiguous. I will show that the risk-averse O-M firm does not