INVESTMENT UNDER DEMAND UNCERTAINTY - THE NEWSBOY PROBLEM REVISITED

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 capaci ty of both the risk-neutral and the risk-averse entrepreneur, without any restriction on the concave utility function and with limited restr ictions on the definition of a mean preserving spread. These general r esults are explained by the fact that the newsboy has a piecewise-line ar, and concave, monetary payoff with a kink endogenously determined a t the level of optimal capacity. Our results are compared with those i n the two literatures on price uncertainty and demand uncertainty, and particularly, with the recent contributions of Eeckhoudt, Gollier, an d Schlesinger [1991, 1995].