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Quantity and price controls by the firm under demand uncertainty and welfare implications
Author(s) -
Adar Zvi,
Arad Ruth
Publication year - 1982
Publication title -
managerial and decision economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.288
H-Index - 51
eISSN - 1099-1468
pISSN - 0143-6570
DOI - 10.1002/mde.4090030306
Subject(s) - economics , monopoly , microeconomics , welfare , ex ante , dominance (genetics) , perfect competition , profit (economics) , social welfare , context (archaeology) , stochastic dominance , expected utility hypothesis , econometrics , financial economics , paleontology , biochemistry , chemistry , biology , gene , political science , law , market economy , macroeconomics
A monopoly facing an uncertain demand can affect its profit distribution through the choice of ex ante controls. This paper compares two modes of behavior ‐ price‐setting and quantity‐setting ‐ in the context of a mean‐variance model. The main results are: (a) With nonlinear cost, the monopoly will not be indifferent between the two modes. In the particular case of quadratic cost, conditions for the dominance of price‐setting over quantity‐setting behavior are derived. (b) Whereas it is well‐known that the risk averse, quantity‐setting monopoly will produce less under uncertainty than under certainty (or risk neutrality), the price‐setting monopoly increases its expected output when faced by uncertain demand, possibly exceeding even the competitive output under uncertainty. (c) Using expected social surplus as a welfare criterion, price‐setting emerges as the welfare‐dominant behavior when there is a conflict between the privately and the socially preferred modes. (d) Finally, there exist conditions where price‐setting monopolies welfare‐dominate a competitive industry facing the same random demand.