Risk in supply response: an econometric application

Abstract

Impact of risk aversion in competitive market models has been analyzed in theory to characterize optimal behavior in different cases from zero to positive levels of risk aversion [1,2,12]. For commodity markets this analysis has important implications for stabilization policies; for, if risk aversion has a significant impact on optimal supply behavior, any policy which reduces risk aversion would also affect optimal supply and therefore suppliers’ incomes. The theoretical hypothesis of risk aversion and its impact on demand supply behavior must have empirical plausibility before they can be utilized for policy purposes. With this objective an econometric attempt is made here to provide a quantitative assessment of the incidence of risk on farmers’ production decisions for a number of California field crops over the years 1949–70. Risk is measured by several surrogate variables like variance of prices, dummy variables suitably constructed and expectational factors. Reasons for analyzing agricultural supply response to changing risk are two-fold. First, the competitive framework very nearly holds in the agricultural sector, where previous econometric studies [5,7] have emphasized the importance of price and yield variability on farmers’ production decisions. Even in less developed countries, where the agricultural sector may not be as competitive as in the developed countries, planted acreages of different field crops have been found to significantly depend on the variances of prices and yields [1,15].