Rice, Risk and Rationality: Supply Response in West Bengal, India

Most studies on rational response of rice producers in less developed countries(LDCs) assume risk–neutrality. However, the role of risk in producer decision making has been recognised as an important determinant of production. It has been shown that competitive risk–averse firms produce a smaller output under price uncertainty than under the assumption of price certainty and that the higher the overall level of risk, ceteris paribus, the lower the output. It is also shown that an increase in price risk may imply a fall in a firm's production in the face of a decreasing absolute risk aversion. If farmers are rational and risk averse in LDCs, they should consider not only expected output prices and yields when allocation resources, but also expected risk in output prices and yields. The extent to which price and yield risks do in fact affect producer decisions is an empirical question. In this paper, we develop a single–equation model as well as a system of equations model to estimate supply response under risky conditions when agents are rational. In particular, a rational expectations model incorporating risk variables is presented. Then, we apply the models to a developing country (Bengal, India) and estimate the validity of the models.