Why Don't Country Elevators Pay Less for Low Quality Wheat? Information, Producer Preferences and Prospect Theory

Previous research found that country elevators that are the first in their area to grade wheat and pay quality-adjusted prices would receive above-normal profits at the expense of their competitors. Because of spatial monopsony, these early-adopting elevators would pass on to producers only 70% of the quality-based price differentials received from next-in-line buyers. If competing elevators also adopted these practices, profits for all elevators would return to near normal, and elevators would pass on to producers nearly all price differentials received from next-in-line buyers. However, that research could not explain why more elevators were not becoming "early adopters" by paying quality-adjusted prices. More recent research found that producers' risk aversion and lack of information about the quality of their wheat could explain more of the failure of country elevators to pass on premiums and discounts. If producers are risk averse, an elevator that imposes discounts for lower quality wheat, even while paying a higher price for high quality wheat, risks losing business if producers believe that a competing elevator may be more likely to pay them a higher price net of discounts. However, even more important is the level of information producers have about the quality of their wheat before selling it to an elevator. Still, these explanations account for only part of elevators' apparent reluctance to pay quality-adjusted prices. Since inconsistencies have been observed between expected utility and individuals' behavior, this research considers the case where producers' preferences can be more appropriately modeled by prospect theory, and whether such preferences can explain more of elevators' reluctance to pay quality-adjusted prices. A simulation model is used to measure the effects of risk-averse producers (in both expected utility and prospect theory frameworks) and limited quality information on profits that can be earned by an elevator that pays quality-adjusted prices. Results indicate that prospect theory helps to explain part, but not all, of the reluctance to pay quality-adjusted prices.