Resource Allocation in a Simple, Two-Sector, Model with Production Risk

Resource allocation in a simple, general-equilibrium model of a 2-sector economy is examined for the situation where production in one sector is subject to a stochastic factor and markets are incomplete, i.e., there are no contingent contracts. Resource allocation is compared in a very simple, 2-good economy when output in one sector, and hence the price ratio, is stochastic with what it would be in the absence of such a disturbance. A closed economy is examined, using the concept of rational expectations to close the model. It is found that with output prices endogenous, resources might be shifted towards the sector in which production is risky, even when producers are risk-averse. Issues are considered for the situation where producers consume only the good of the non-stochastic sector and for the more general case where producers consume both goods.