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Predicting the Effects of Technological and Regulatory Change - Q2 1999 Status Report

Farm milk prices in the U.S. have recently experienced unprecedented volatility. Price and yield uncertainty, related to market, policy, and weather conditions set the environment in which dairy producers must make decisions. Land grant universities as well as government and private agencies have been exploring mechanisms to help milk producers deal with the new uncertainty that comes from price and yield volatility. As part of a M.S. thesis, an Argentinean graduate student and I used our Intel grant computer to construct and solve a mathematical model of dairy production in the Santa Fe Sur region of Argentina. All sources of uncertainty (objective function, technical, and right-hand-side) were modeled by simulating different states of nature, corresponding to individual years in the 1992-1997 period. The full model was formulated using linked Excel spreadsheets representing forage cropping, feed supply, livestock management, and labor activities. It contained 847 activities and 1,069 constraints and was solved in seconds using What’s Best from Lindo Systems Inc.

We found that, compared to production plans generated by ‘rules-of-thumb’ or to our best estimate of current practices, the optimal resource allocation for the Argentinean dairy situation was only slightly better in terms of net returns. Simulating numerous states of nature, which was made possible by the Intel computer, we did find that the optimal plans indicated that dairy producers are better-off planning for "bad" years. That is, the gains from following production plans that are optimized for the good years or even the average years do not offset the losses of following those plans during bad years. The ‘common knowledge’ that farmers are risk averse when it comes to uncertain situations may not be knowledge at all, but a mistaken association of what appears to be conservative behavior with a presumption of utility preference. The observed behavior may actually be optimizing behavior. This finding would have impacts on the types of policy instruments needed to help dairy producers address the new order of price and yield variability.

We have submitted proposals to the USDA to further develop this model for the U.S. context and to analyze optimal resource allocation in the face of U.S. price and yield volatility.

30 June, 1999

James E. Pratt, Senior Research Associate, Department of Agricultural, Resource, and Managerial Economics

Last modified on: 10/12/99