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Investment Under Demand Uncertainty: The Newsboy Problem Revisited

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  • Georges Dionne

    ([1] Economics Department, Université de Montréal, C.P. 6128, Succursale Centre-ville, H3C 3J7 Montréal, Québec, Canada [2] Risk Management Chair, HEC-Montréal)

  • Tahar Mounsif

    (Université de Montréal and Université de Rabat)

Abstract

In this article we study the effect of uncertainty on an entrepreneur who must choose the capacity of his business before knowing the demand for his product. The unit profit of operation is known with certainty, but there is no flexibility in our one-period framework. We show how the introduction of global uncertainty reduces the investment of the risk-neutral entrepreneur and, even more, that of the risk-averse one. We also show how marginal increases in risk reduce the optimal capacity of both the risk-neutral and the risk-averse entrepreneur, without any restriction on the concave utility function and with limited restrictions on the definition of a mean preserving spread. These general results are explained by the fact that the newsboy has a piecewise-linear, and concave, monetary payoff with a kink endogenously determined at the level of optimal capacity. Our results are compared with those in the two literatures on price uncertainty and demand uncertainty, and particularly, with the recent contributions of Eeckhoudt, Gollier, and Schlesinger [1991, 1995]. The Geneva Papers on Risk and Insurance Theory (1996) 21, 179–189. doi:10.1007/BF00941937

Suggested Citation

  • Georges Dionne & Tahar Mounsif, 1996. "Investment Under Demand Uncertainty: The Newsboy Problem Revisited," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 21(2), pages 179-189, December.
    • Handle: RePEc:pal:genrir:v:21:y:1996:i:2:p:179-189
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    Cited by:

    1. Touhami, A. & Martens, A., 1996. "Macroemesures in Computable General Equilibrium Models: a Probabilistic Treatment with an Application to Morocco," Cahiers de recherche 9621, Universite de Montreal, Departement de sciences economiques.
    2. Hau, Arthur, 2010. "Comparative statics of changes in risk on monotonically and partially responsive kinked payoffs," European Journal of Operational Research, Elsevier, vol. 201(1), pages 267-276, February.
    3. Amigues, Jean-Pierre & Favard, Pascal & Gaudet, Gerard & Moreaux, Michel, 1998. "On the Optimal Order of Natural Resource Use When the Capacity of the Inexhaustible Substitute Is Limited," Journal of Economic Theory, Elsevier, vol. 80(1), pages 153-170, May.
    4. Watt, Richard & Vázquez, Francisco J., 2017. "An analysis of insurance demand in the newsboy problem," European Journal of Operational Research, Elsevier, vol. 259(3), pages 1064-1072.
    5. Jorge Ibarra-Salazar, 2005. "The Newsboy Model: Changes in Risk and Price," The Geneva Papers on Risk and Insurance Theory, Springer;International Association for the Study of Insurance Economics (The Geneva Association), vol. 30(1), pages 99-109, June.
    6. Hennessy, David A. & Roosen, Jutta, 1999. "Stochastic Pollution, Permits, and Merger Incentives," Journal of Environmental Economics and Management, Elsevier, vol. 37(3), pages 211-232, May.

    More about this item

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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