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Native Grassland Conversion: the Roles of Risk Intervention and Switching Costs

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We develop a real option model of the irreversible native grassland conversion decision. Upon plowing, native grassland can be followed by either a permanent cropping system or a system in which land is put under cropping (respectively, grazing) whenever crop prices are high (respectively, low). Switching costs are incurred upon alternating between cropping and grazing. The effects of risk intervention in the form of crop insurance subsidies are studied, as are the effects of cropping innovations that reduce switching costs. We calibrate the model by using cropping return data for South Central North Dakota from 1989 to 2012. Simulations show that a risk intervention that offsets 20% of a cropping return shortfall increases the sod-busting cost threshold, below which native sod will be busted, by 41% (or $43.7/acre). Omitting cropping return risk across time underestimates this sod-busting cost threshold by 23% (or $24.35/acre), and hence underestimates the native sod conversion caused by crop production. JEL Classification: Q18, Q38, H23

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Paper provided by Center for Agricultural and Rural Development (CARD) at Iowa State University in its series Center for Agricultural and Rural Development (CARD) Publications with number 13-wp536.

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Date of creation: Feb 2013
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Handle: RePEc:ias:cpaper:13-wp536

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Keywords: conservation tillage; crop insurance policy; irreversibility; native grassland; sod busting.;

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  1. Claassen, Roger & Cooper, Joseph C. & Carriazo, Fernando, 2011. "Crop Insurance, Disaster Payments and Land Use Change: The Effect of Sodsaver on Incentives for Grassland Conversion," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 43(02), May.
  2. Atanu Ghoshray, 2013. "Dynamic Persistence of Primary Commodity Prices," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 95(1), pages 153-164.
  3. David A. Hennessy, 2004. "On Monoculture and the Structure of Crop Rotations," Center for Agricultural and Rural Development (CARD) Publications 04-wp369, Center for Agricultural and Rural Development (CARD) at Iowa State University.
  4. Dixit, Avinash K, 1989. "Entry and Exit Decisions under Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 620-38, June.
  5. Barry K. Goodwin & Monte L. Vandeveer & John L. Deal, 2004. "An Empirical Analysis of Acreage Effects of Participation in the Federal Crop Insurance Program," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 86(4), pages 1058-1077.
  6. Lubowski, Ruben N. & Bucholtz, Shawn & Claassen, Roger & Roberts, Michael J. & Cooper, Joseph C. & Gueorguieva, Anna & Johansson, Robert C., 2006. "Environmental Effects Of Agricultural Land-Use Change: The Role Of Economics And Policy," Economic Research Report 33591, United States Department of Agriculture, Economic Research Service.
  7. Joseph W. Glauber, 2013. "The Growth Of The Federal Crop Insurance Program, 1990--2011," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 95(2), pages 482-488.
  8. Walter Enders & Matthew T. Holt, 2012. "Sharp Breaks or Smooth Shifts? an Investigation of the Evolution of Primary Commodity Prices," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 94(3), pages 659-673.
  9. Doole, Graeme J. & Hertzler, Greg, 2011. "Optimal Dynamic Management of Agricultural Land-Uses: An Application of Regime Switching," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 43(01), February.
  10. C. Edwin Young & Monte L. Vandeveer & Randall D. Schnepf, 2001. "Production and Price Impacts of U.S. Crop Insurance Programs," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 83(5), pages 1196-1203.
  11. Carriazo, Fernando & Claassen, Roger & Cooper, Joseph C. & Hellerstein, Daniel & Ueda, Kohei, 2010. "Grassland to Cropland Conversion in the Northern Plains: The Role of Markets and Policy," 2010 Annual Meeting, July 25-27, 2010, Denver, Colorado 61625, Agricultural and Applied Economics Association.
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