PRUDENCE, DEMAND UNCERTAINTY, BACKGROUND RISK, AND THE LAW OF SUPPLY - A NONEXPECTED UTILITY APPROACH TO THE FIRM

We identify two motives, prudence and risk aversion, which give rise t o precautionary behavior for a quantity- or price-setting monopolist f acing demand uncertainty who has dual theoretic preferences. We also a nalyze a piecewise linear profit function due to a tax on profits that varies with the profit level. We show that the comparative statics of greater risk (mean-preserving spread and mean-utility preserving spre ad) can be totally or partially determined by the Diamond-Stiglitz and Kihlstrom-Mirman single-crossing property. For example, for a prudent risk-averse quantity-setting dual theoretic monopolist, a mean-preser ving spread will have the same impact on output under uncertainty as a fall in the state of demand under certainty. Finally, we find that, i n contrast to expected utility, a stochastically larger state of deman d (first-order stochastic dominance) will raise output even if backgro und risk is present.