On the Dynamics of Production under Cost Uncertainty

Abstract

In planning the production of many large projects which usually take a long time to complete, entrepreneurs are often faced with several aspects of uncertainty. We derive the ex ante optimal plan for production of a large capital unit with production factors whose prices might change at some unknown future date. Two different plans are derived. The first, the noncommitment plan, is the best ex ante policy or strategy which specifies one path conditional on the nonoccurrence of the date when the unit cost changes, and another path given that the date of change has occurred. It is shown, given the assumptions in the paper, that the optimal input path when the date of change is known will start at a lower level than the conditional optimal input path when the date of change is unknown ex ante. The second plan is a so-called commitment plan. It is determined in such a way that the entrepreneur, for various reasons, has to pursue the policy which is announced initially. This plan is suboptimal if no commitments are to be made.

I am grateful to Michael Hod and Aanund Hylland for stimulating discussions and two anonymous referees for useful comments on an earlier version of this paper.