The Role of a Variable Input in the Relationship between Investment and Uncertainty
Posted: 28 Sep 2004
For a perfectly competitive firm with a constant returns to scale technology, a greater price uncertainty has been shown to increase investment even in the presence of rreversible investment. We show, however, that the option value generated by a one-time fixed cost can cause increasing uncertainty to reduce investment from a positive value to zero. This occurs as the negative effect of the option value dominates the conventional positive effect for certain values of a key parameter, namely labor share. When labor share is small, the negative effect from increased uncertainty is more likely to dominate the positive effect. When it is large, the opposite holds.
Keywords: Investment, Uncertainty, Labor Share, Convexity
JEL Classification: E22
Suggested Citation: Suggested Citation