The Role of a Variable Input in the Relationship between Investment and Uncertainty

Posted: 28 Sep 2004

See all articles by Jaewoo Lee

Jaewoo Lee

International Monetary Fund (IMF) - Research Department

Kwanho Shin

Korea University

Abstract

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

Lee, Jaewoo and Shin, Kwanho, The Role of a Variable Input in the Relationship between Investment and Uncertainty. American Economic Review, Vol. 90, pp. 667-680, June 2000. Available at SSRN: https://ssrn.com/abstract=596141

Jaewoo Lee

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-7331 (Phone)
202-623-6334 (Fax)

Kwanho Shin (Contact Author)

Korea University ( email )

1 Anam-dong 5 ka
Sunbuk-Ku, Department of Economics
Seoul 136-701
Korea
82-2-3290-2220 (Phone)
82-2-3290-2719 (Fax)

HOME PAGE: econ.korea.ac.kr/~khshin

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