This paper explores how Knightian uncertainty affects dynamic properties in an economic growth model. The decision-making theory employed in the analysis is the theory of expected utility under a non-additive probability measure, i.e., the Choquet expected utility model of preference. We apply this decision-making theory to an overlapping generations model where producers face "uncertainty" in their technologies. When the producer is averse to uncertainty, the firm's profit function may not be differentiable. Therefore, the firm's decision to invest and hire labor becomes rigid for a certain measurable range of real interest rates. In dynamic equilibrium, the existence of firm-level rigidity causes discontinuity in the wage function; this makes multiple equilibria the more likely outcomes under the log utility and Cobb-Douglass production functions. In this paper, we show that even if aversion to uncertainty is small, the "poverty trap" can arise for a wide range of parameter values. (Copyright: Elsevier)
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.
Volume (Year): 11 (2008) Issue (Month): 3 (July) Pages: 652-663 Download reference. The following formats are available: HTML,
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Find related papers by JEL classification: D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Investment, or Financing E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
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