The effect of irrigation on income volatility reduction: a prospect theory approach

Irrigation produces a significant increase in crop yields and a noticeable reduction in annual yield variability. These two factors make irrigation an attractive economic practice through direct impact on the profitability of crops (positive in levels and negative in dispersion). When irrigation supplements natural precipitation on rain-fed summer crops, this effect is even more evident. The typical economic feasibility analysis of supplemented irrigation is from a financial point of view. However, these methodologies fail to consider the benefits accrued from income stability. In this study, we monetarily quantify these benefits using a Prospect Theory approach. We compare the certainty equivalent of the stochastic profit flow of a farmer applying supplemented irrigation to a crop rotation to that of a farmer who does not use irrigation and crops in a rain-fed system, using a cumulative Prospect Theory utility function in both cases. Our application evaluates summer crops in Uruguay. We find that the farmer values income stability from irrigation (i.e., lower volatility) between 20 to 32% of the total benefit he assigns to the use of irrigation. We build scenarios with different production orientation of the operation, soil aptitude, distance to the port, and attitudes towards risk, and in all cases, farmers attribute a considerably high value to the lower volatility. These results contribute to the efforts and policies seeking to promote irrigation adoption