Flexibility, Uncertainty, and Economic Theory

Abstract

Flexibility is a concq)t that has croppd up a number of timcs in the dcvelopmcnt of micro-economic theory. The notion that good current actions may ~C J those which permit good later responses to later observations has appeared in discussions about choice of plant (Stigler [I:{], Hart (4, 51) and of portfolio (1. Marschak (91). Recently the iiotiori lias appearecl again in an analysis of clecisionmaking in thc conduct of licscrirch ant1 Ilcvclopmcnt (171, 181, [IO]).In cach of these discussions it is conjectured or a r g u d that flexibility (of plant, portfolio, or X and D policy) is good in an uncertain world.The diversity of the cascs discusscd tempts one to broaden the conjecture to cover all of them (and others) at once.As additional problems in sequential decision-making under uncertainty are investigated (and wliat economic prohlcms facing firm or household arc not csscntially of this kind?) the notion of flexibility seems likely to play a larger role in economic theory.It is perhaps time, thcrefore, to propose some precise definitions (or measures) of flexibility, to formulatc the above conjecture using the definitions, and to see if the coiijccture is truc in some simple cases.We attempt to do so licre. Section I formulates some dcfinitioiis of flexibility, Sectioii I1 makes a conjecture about the value of flexibility as uncertainty grows, and Section 111-V apply the definitions and test the conjccture in three simple cascs. Two of the caws are the classic oncs niciitioned above and the third has to do with the conduct of Research ant1 I)cvclopnicnt. 'rO\YAHD A 1)IJFINITION OF FLEXIBILITT.Many decision problcms are charac terizecl by tlic following structurc:a) The payoff to the dccision maker is a function of a sequciice of actions takcn by hiin, at times t, , t, , ... , t, , ... , a d a sequence of states of thc world bcyond his control. b) At any point in the decision sequence, the decision maker has less than pcrfect infornration about what the future sequence of states of thc world will be.

An Empirical Study of Manufacturing Flexibility in Printed Circuit Board Assembly

“…The work of Stigler (1939) and Marschak and Nelson (1962), mentioned earlier, providetheoretical support for this perspective. Thus, the flexibility implied by larger volume fluctuations may have to be weighed against these potential negative effects on cost and quality.…”

“…His reasoning, as re-interpreted and formalized by Marschak and Nelson (1962), is that a firm's volume flexibility is reflected in the shape of its average total cost function. A flat average cost function gives a firm more flexibility, as it can depart from the optimal output without much cost penalty.…”

Agent-based Modeling for Decision Making in Economics under Uncertainty

“…Decision makers are then faced with the problem that an action taken now may later appear to be a poor choice because it limits the options or causes undesired, irreversible effects. Under such information uncertainty, "good current actions may be those which permit good later responses" (Marschak and Nelson, 1962), i.e. a certain degree of flexibility in actions later may be preferred to be able to act upon new information when it becomes available.…”

Bargaining, Mergers, and Technology Choice in Bilaterally Oligopolistic Industries

“…30 Instead of a change in production costs, we could also imagine that 29 As the two suppliers produce differentiated products, assuming that only one supplier has the choice to switch to a production technology is not unrealistic. 30 The analysis of volume ßexibility in the context of technology choice has been pioneered by Stigler (1939) and Marshak and Nelson (1962). The subsequent literature has mainly focused on the interaction with demand uncertainty (see, e.g., Vives (1986Vives ( , 1989, Eaton and Schmitt (1994), and Boyer and Moreaux (1997)).…”