Firm Decision Making under Both Input and Output Price Uncertainty

Abstract

Theory of the firm suggests that optimal production levels decrease as output price becomes random. Firms operating in industries with long production lags are also exposed to input price uncertainty. This paper provides a novel decision theoretic model in the presence of both input and output price uncertainty and uses U.S. beef sector data to test theoretical propositions concerning firm behavior. Our findings confirm that, in a two-stage production, the introduction of input price uncertainty leads to increased use of the input and an increased level of output in stage one and a decreased level of output in stage two.