Optimal Production Decision with Disappointment Aversion under Uncertainty

This paper uses four different disappointment models to examine the production decision of the competitive firm under uncertainty when the firm is not only risk-averse, but also disappointment-averse. We show the conditions under which the disappointment-averse firm will produce less than its risk-averse counterpart. We also develop properties for the comparative statics of the optimal production and compare the results of using different disappointment-averse and risk-averse models. We show that the disappointment-averse firm's optimal output level will surely decrease with an increase in the disappointment coefficients or with an increase in the probability that the random output price takes a low value. The implication of our results is that even with an expectation of higher prices, the firm could produce less than that with risk aversion. This could explain why production recovery could be delayed, even though the firms predict output price will increase significantly in the future. Last, we show that at the optimum, the marginal rates of substitution for all the disappointment-averse models are equal to the slope of the isoprofit line