8. Optimising Production Under Uncertainty

This is the main chapter in which the concepts and tools developed in the previous chapters are used to derive criteria for optimal use and combination of inputs when producing under uncertainty. The chapter includes a formal definition of ‘good’ and ‘bad’ states of nature, and it derives criteria for optimal application of various types of input for risk-neutral and risk-averse decision makers. Although it is not possible to derive operational criteria for risk averse decision makers unless one knows the utility function, the analysis using the state-contingent approach provides interesting and operational results for risk neutral decision makers. It also reveals that even if one knows the form of the utility function, then it is not possible to determine uniquely whether risk-averse decision makers will use more or less input than risk-neutral decision makers.