This paper attempts to develop a model which explains a monopolistic firm's decisions on production, price and inventory under uncertainty, and it further attempts to derive rules which characterize the firm's optimal behavior.
First, we assume that the firm is fully aware of the stochastic process generating the consumers' income and maximizes the expected sum of discounted profits over N periods. Second, we construct a stochastic dynamic model which optimizes a quadratic criterion. Then, by means of the Kalman filtering technique, we derive optimal decision rules which include distributed lags.
As a result of our analysis, we find that policy decisions become more autoregressive when adjustment costs increase, and that weights of distributed lags become smaller when a subjective discount rate increases.
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