PRODUCTION, MARKETING, AND STORAGE DECISIONS UNDER RISK FOR CASH-GRAIN AND CROP-HOG FARMS IN WEST-CENTRAL INDIANA

WILLIAM DONALD SHURLEY, Purdue University

Abstract

The decade of the 1970's has been one with highly volatile farm prices. This increased price variability, together with the random effects of exogenous variables, such as weather, on crop yields has substantially increased the overall risk in the farm business. Farm income variation creates problems in financial planning and returns to fixed resources are largely unknown. Price and production uncertainty causes farmers to rely on their expectations in farm-firm decision making. Efficient resource allocation depends on the accuracy of farmer expectations. This study uses a model framework which allows two elements of income uncertainty--price variability and crop yield variability--to be incorporated into farm-planning decisions. Risk is defined as variance in income. Crop production risk is dependent on the weather conditions each year and the timeliness of field operations. Price risk is dependent on how the crop is marketed. Two typical farming operations are modeled--a cash-grain farm and a crop-hog farm. Four crops are considered--corn, soybeans, wheat, and wheat-soybean double-crop. The hog operation is a low-investment, farrow-to-finish, confinement system. Farmers can reduce income risk by a choice of cash sale or forward contract marketing options. This concept of market diversification together with crop acreage diversification constitutes a risk management program. This approach is not unique. An important contribution of this study, however, is in establishing the importance of on-farm storage in developing this risk management program. Each farming operation is constructed as a separate model. The approach was to model each within the structure of the Purdue B-9 Farm Planning Model. The original model was expanded to incorporate a total of 44 market options and also expanded to incorporate the hog enterprise. Risk is incorporated by modeling within the MOTAD framework and using the standard deviation rather than the variance in returns as the risk measure. Generally, the major conclusions from the study were that although risk and risk aversion are important decision-making components, the effect is more on the choice of market plans than on the acreage mix. Also, storage capacity is a major factor in the choice of market plans and thus the level of income. More importantly, however, results showed that increases in storage capacity (either on or off-farm) are profitable only if the farmer has a low degree of risk aversion. Market and acreage plans at higher degrees of risk aversion do not warrant high levels of storage. The hog operation was modeled as an alternative "market" for corn produced on the farm. The hog enterprise was not attractive in a marketing sense because although it increased income substantially, it also greatly increased income risk. This is because the hog operation is a source of both income risk and the risk of feeding uncertain on-farm corn supplies to hogs. This was modeled within the MOTAD framework using a modification of the Wicks and Guise technique. The model results produce a set of crop acreage and marketing plans which can serve as long-range guidelines for Corn Belt farmers. These plans are ones which maximize the objective function for a given level of risk aversion over the ten-year period considered. However, in any given year, specific factors may lead a farmer to follow a different production-marketing strategy.

Degree

Ph.D.

Subject Area

Agricultural economics

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