Wage Distortion and Resource Allocation under Uncertainty

Abstract

The effects of uncertainty on resource allocation have been examined in a two-sector general equilibrium model of production. Constructing a model in which firms are risk indifferent and face uncertainty regarding the use of capital, Rothenberg and Smith [9] considered the implications of uncertainty for welfare, resource allocation and income distribution. Their model was refined by Batra [3] to permit uncertainty in production to influence the firms' decisions to hire both capital and labor. Batra's approach appears to be more general in that producers are assumed to be risk averse in lieu of risk neutral. The writing of this paper is inspired by Batra's contributions [2; 3]. Batra's well-known intermediate run equilibrium model' is reformulated to allow for wage distortion. Utilizing the model, several issues regarding the effects of changes in factor supplies, in commodity prices and in the degree of wage distortion will be examined. Factor market distortions in the absence of uncertainty have been studied extensively in literature;2 their impacts on resource allocation in stochastic environment have not been explored, however. We argue that the introduction of the wage differential has a major impact on Batra's results. First, relative value factor intensities generally replace relative physical factor intensities in determining signs of