Why do Farmers Voluntarily Accept Risk?

Many individuals voluntarily engage in risky activities when they could be avoided.  This is particularly true of farmers.  For example, many U.S. corn farmers do not irrigate their crop even though they face the risk of inadequate rainfall or drought.  One possible explanation for this type of behavior is that some individuals like risk.  However, this explanation is contrary to what most researchers find regarding individual risk preferences.  A more satisfactory explanation recognizes that most risky decisions are characterized by an important risk and reward tradeoff.  Some simple examples can solidify the intuition of these tradeoffs. 

Suppose an individual has a choice between (i) $75 for certain and (ii) an equal chance at $150 and nothing.  First, note that (ii) is characterized by risk, while (i) is not.  Second, note that individuals can expect to earn $75 on average for both choices.  Which of these alternatives an individual will choose depends on the individual’s risk attitudes — risk averse individuals will prefer (i), risk preferring individuals will prefer (ii), and risk neutral individuals will be indifferent.  Intuitively, risk averse individuals do not like the variability of (ii), while risk preferring individuals do.  Given that research shows that most individuals are risk averse, we would expect most individuals to choose (i) over (ii).

Uganda / © Claudia Dewald

Now suppose an individual has a choice between (iii) $50 for certain and (ii) an equal chance at $150 and nothing.  Again, (iii) is risky, while (i) is not.  But, on average, individuals choosing (i) earn $50, while individuals choosing (iii) earn $75.  While risk preferring individuals will certainly prefer (iii) because they earn more on average and have more variable outcomes, risk averse individuals may prefer (i) or (iii) depending on their degree of risk aversion.  That is, risk averse individuals will often be willing to voluntarily accept risk because risk is typically not the only thing that is important to them.  They are typically interested in the expected outcome as well as the variability of outcomes. 

Many farmers choose not to irrigate because irrigation is costly.  Therefore, while irrigation may reduce the variability of yields and may even increase average yields, it can also decrease average net income by more than a farmer’s risk premium.  Most decision individuals and farmers make are characterized by analogous risk and reward tradeoffs.