IFPRI’s Applied Microeconomics & Development Seminar Series provides a forum for researchers to present top-quality applied microeconomics and development work. Seminars are held on the first and third Thursdays of each month at IFPRI’s Washington DC office (2033 K St NW). Please contact Julie Lang (email@example.com) if you have any questions.
Speaker: Marc Bellemare, Associate Professor at University of Minnesota
Conference Room 7AB
Producer Attitudes to Output Price Risk: Evidence from the Lab and from the Field
In a seminal article, Sandmo (1971) showed that when faced with an uncertain output price, a risk-averse firm manager would hedge against price risk by producing less than she would have had she been faced with a certain output price equal to the mean of the uncertain output price distribution. In a follow-up article, Batra and Ullah (1974) showed that the firm manager further decreases her production level in response to increases in risk if her preferences exhibit decreasing absolute relative risk aversion (DARA). We bring both of those theoretical predictions to the lab and to the field. Based on an experimental setup that exactly mimics Sandmo’s theoretical framework, we first study the effect of price risk on production relative to price certainty. Then, we study the effect of mean-preserving spreads of the price distribution on production. We find that our subjects increase their production in response to price risk at the extensive margin but decrease their production in response to price risk at the intensive margin. If expected utility theory is an accurate representation of behavior, our results suggest that our subjects are risk-loving but that their preferences exhibit DARA. Eliciting our subjects’ risk preferences by way of a Holt-Laury list experiment, we find that our subjects are not risk-loving, and we find little to no support for the the hypothesis that their preferences exhibit DARA. Looking at a number of alternative theories, we find that prospect theory explains our subjects’ behavior. Lastly, estimates derived from a structural model of producer behavior in the face of price risk show that our subjects have heterogeneous price risk preferences.