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The Role of Risk in the Decision to Produce Post-Decoupling - A Stochastic Budgeting Example

Author

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  • Thorne, Fiona S.
  • Hennessy, Thia C.

Abstract

Under the Mac Sharry and Agenda 2000 reforms, direct payments comprised a significant portion of farmers' income in the EU. Farmers had to engage in production to receive these payments but the payments were relatively risk-free and therefore risk may not have played an important role in the production decision. This paper considers the effect of the decoupling of direct payments from production in the EU and in particular, on the role of production risk in the decision making process. In an environment where direct payments are completely decoupled from production, farmers may engage in an 'entitlement farming' system, that is retain their land only to activate the decoupled payment and not actually produce any tangible goods. This paper examines the effect of production risk on the economic trade off between 'entitlement farming' and conventional farming. A stochastic budgeting model is developed for two representative farms. The model is used to measure the probability that the returns to the 'entitlement farming' system could be higher than the profit emanating from a conventional farming system given production risk. The results show that for the less efficient representative farm, the probability of achieving a significantly higher profit by engaging in entitlement farming is 46 percent, while further analysis shows that there is a 9 percent probability that profits from conventional farming systems would be only marginally higher than the 'entitlement farming' option.

Suggested Citation

  • Thorne, Fiona S. & Hennessy, Thia C., 2006. "The Role of Risk in the Decision to Produce Post-Decoupling - A Stochastic Budgeting Example," 2006 Annual Meeting, August 12-18, 2006, Queensland, Australia 25415, International Association of Agricultural Economists.
  • Handle: RePEc:ags:iaae06:25415
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    File URL: http://purl.umn.edu/25415
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    References listed on IDEAS

    as
    1. Harwood, Joy L. & Heifner, Richard G. & Coble, Keith H. & Perry, Janet E. & Somwaru, Agapi, 1999. "Managing Risk in Farming: Concepts, Research, and Analysis," Agricultural Economics Reports 34081, United States Department of Agriculture, Economic Research Service.
    2. Maurice J. Roche & Kieran McQuinn, 2003. "Grain price volatility in a small open economy," European Review of Agricultural Economics, Foundation for the European Review of Agricultural Economics, vol. 30(1), pages 77-98, March.
    3. Lien, Gudbrand, 2003. "Assisting whole-farm decision-making through stochastic budgeting," Agricultural Systems, Elsevier, vol. 76(2), pages 399-413, May.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Decoupling; Risk Analysis; Production Risk; Decision Analysis; Stochastic Modelling; Agricultural and Food Policy; Risk and Uncertainty; Q12; Q18;

    JEL classification:

    • Q12 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Micro Analysis of Farm Firms, Farm Households, and Farm Input Markets
    • Q18 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Agricultural Policy; Food Policy

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