Author
Listed:
- Liu, Yanyan
- Black, J. Roy
Abstract
By altering the probability distribution of farm income, crop insurance programs affect farmer's input use decision. Ramaswami's (1993) one-shock model analyzed the effect of the crop insurance on single input use by allowing the randomness of yield while keeping price constant in revenue determination. The total effect of actuarially fair insurance on input use was decomposed into risk reduction effect and moral hazard effect, and the directions of the two effects were examined. He showed that the total impact of actuarially fair crop insurance on input use was a) to reduce it if the input was risk decreasing and b) indeterminate if the input was risk increasing. However, the evidence from previous empirical work has been mixed. Horowitz and Lichtenberg (1993) suggested insured farmers raising corn use more fertilizers and pesticides while Smith and Goodwin (1996) obtained the opposite result for wheat. Smith and Goodwin also used more comprehensive econometric tests and had a higher quality data set. A common belief is that fertilizer is risk increasing and pesticide risk decreasing. Ramaswami's model assumed crop price was constant and yield was the only source of randomness in farmer's revenue. In reality, market price is a random variable and often negatively correlated with the farmer's yield. For example, bad weather conditions tend to reduce yield across farms in a common region, which may cause diminished quantities supplied and higher crop price. Our paper extends Ramaswami's one-shock model to a two-shock model, and generalizes the two propositions in that paper by introducing randomness to price as well as yield. With two random shocks, the total insurance effect on input use is indeterminate for both risk increasing and risk decreasing inputs, which is consistent with the mixed empirical evidence. Our study also provides a numerical method to decompose the total insurance effect into a risk reduction effect and a moral hazard effect using empirical data. The simulation based on 75 percent coverage level suggests the total insurance effect is economically small to the farmer as are the risk reduction effect and moral hazard effect under mild risk aversion. And the moral hazard effect is less significant than the risk reduction effect. However, the moral hazard effect becomes larger if a higher coverage level is used.
Suggested Citation
Liu, Yanyan & Black, J. Roy, 2004.
"A Two-Shock Model Of The Impact Of Crop Insurance On Input Use: Analytic And Simulation Results,"
2004 Annual meeting, August 1-4, Denver, CO
19947, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
Handle:
RePEc:ags:aaea04:19947
DOI: 10.22004/ag.econ.19947
Download full text from publisher
Corrections
All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ags:aaea04:19947. See general information about how to correct material in RePEc.
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
We have no bibliographic references for this item. You can help adding them by using this form .
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: AgEcon Search (email available below). General contact details of provider: https://edirc.repec.org/data/aaeaaea.html .
Please note that corrections may take a couple of weeks to filter through
the various RePEc services.