Supply response to countercyclical payments and base acre updating under uncertainty: an experimental study.

Roth, A. 1995. "Introduction to Experimental Economics." In J. Kagel and A. Roth, eds. Handbook of Experimental Economics. Princeton, NJ: Princeton University Press.

Westcott, P. 2005. "Counter-Cyclical Payments under the 2002 Farm Act: Production Effects Likely to be Limited." Choices 20:201-05.

Westcott, P., C. Young, and J. Price. 2002. "The 2002 Farm Act: Provisions and Implications for Commodity Markets." ERS Agric. Information Bull. No. AIB778.

Young, E., D. Skully, P. Westcott, and L. Hoffman. 2005. "Economic Analysis of Base Acre and Payment Yield Designations under the 2002 U.S. Farm Act." ERS Economic Research Report Number 12.

(1) "Base acreage" refers to a farm's crop-specific acreage of wheat, feed grains, cotton, rice, oilseeds, or peanuts eligible to participate in commodity programs under the 2002 Farm Act. Base acres and yields determine the level of government (direct and counter-cyclical) payments and reflect a farm's historical level of acres and yields. Under the 1996 Farm Act, production flexibility contract (PFC) acreage and payment yields for most producers were generally based on--as in prior legislation--the crop mix and prevailing yields during the 1981-1985 period. The 2002 Act allows farmers to update this mix by (a) adding newly eligible crops (i.e., oilseeds) to their current mix, or (b) revising base acreage to reflect plantings during 1998-2001. We refer to "farmers" or "producers" assuming they own the base acreage.

(2) By "nonbase" crop, we take the farmer's perspective: crops for which the producer does not have a production history or an established base, or a crop ineligible for program payments.

(3) Planting a base crop ensures a higher minimum income received due to CCP subsidies and therefore can create an incentive for farmers to allocate crops such that they maximize their minimum possible revenue, usually called a maximin solution in decision theory.

(4) The more risk averse the person, the more likely they would engage in a maximin strategy or one that allows for a higher maximin earnings in the future (planting for or maintaining base).

(5) For a more detailed presentation of the main commodity policy provisions of the 2002 Farm Act, and a comparison with provisions available under the 1996 Farm Bill, see the ERS, USDA side-by-side analysis available on the ERS website at: http://www.ers.usda.gov/Features/FarmBill/Titles/TitleICommodities.htm.

(6) For each crop, the CCP payment rate = (Target price )--(Direct Payment rate)--{Maximum [commodity price, loan rate]}.

(7) Following standard experimental procedures, we used context-neutral terms. Although farmers typically posses base acreage for several crops, we endowed the subjects with base acreage of one crop ("blue"). One can consider the other crop ("red") either a crop not eligible for government payments (a nonprogram crop) or a program crop the farmer had not previously planted. Because we exclude the marketing loan program, the "red" crop can be thought of as any nonbase crop.

(8) We control for order of play of the cases by using two sequences (called treatments): (a) Baseline, CCP, then Policy risk case; and (b) Baseline, Policy risk, then CCP.

(9) The 2002 Act provides DPs similar to the former production flexibility contract (PFC) payments. Direct payments are tied to base acreage, but are completely decoupled from a farmer's current planting choices and current market prices. We include DPs in the baseline case because, although not affecting current production decisions, they constitute one part of government payments that may be at risk if mandatory base updating is instituted (a possibility introduced in the Policy risk case). Recall that CCPs are also decoupled from production decisions, but are linked to current market prices of the farmer's base crops.

(10) These random draws made the prices of our crop options independent. With correlated prices, CCPs still provide maximin incentives for planting base crops.

(11) The inequalities (presented in Table 2) either within or across the lotteries are not necessarily the same numerically or by percentage; it is a general pattern.

(12) Dominance means here that the monetary rewards dominate the subjective costs of making choices in the experiment, or any other motivation.

(13) We isolated the impact of CCPs by assuming no marketing loan program.

(14) Note a caveat about our experimental design. We recognize our design has people making one-time decisions over many rounds. Our representation of a base acre updating policy does not reflect current legislation. The 2002 Act gave farmers the one-time option of updating base acres to reflect recent planting history and this base acreage is in effect for the remainder of the Farm Act. In the Policy risk case, if the updating policy was randomly chosen the participants faced a mandatory updating of their base acres based on the token allocation decisions made earlier that round. Current program benefits (bonuses) were potentially reduced for that round while base acres in subsequent rounds were unaffected (start with 100 base acres in each round). This is a simplification of the current Farm Act's updating procedure, in which base acres could have been changed based on average plantings of program crops during 1998-2001 (Westcott, Young, and Price 2002). While our design represents a potential policy for updating, it is a simplification of the potential range of future updating options, should they occur at all. Attempting to include updating based on current policy would have greatly complicated the current design without necessarily providing much additional insight.

(15) Using the Decision Tool was optional. As in the wilds, subjects who understand expected value and variance may use such tools to help their decisions, while others need not.

(16) Experimental instructions can be found on-line at the AgEcon Search website, http://agecon.lib.umn.edu/.

(17) This test is designed to elicit the subjects' risk preference by asking them to make nine choices. Each choice is called a "game" and involves selecting either the sure bet of $2.50 or playing a tottery with a chance of winning $0 or $5. In each game the probability of the $5 payoff changes ranging in 10% increments from 10% to 90% (presented as numbers from 1 to 10; e.g., $0 if a 2, 3, 4, 5, 6, 7, 8, 9, or 10 is drawn, $5 if a 1 is drawn). A random draw determines which "game" is played. If the subject chooses the lottery for the randomly drawn game a randomly drawn whole number between one and ten determines which payoff they receive ($0 or $5). The draws were not done until subjects were finished with the main experiment. Similar designs have been used by Holt and Laury (2003) and Lusk and Coble (2003).

(18) Subjects had to answer all true/false case quiz questions correctly before proceeding. If after several attempts on their own the student was unable to answer them all correctly, the moderator would have them fill out the answers they believed to be correct and discuss any wrong answers until they were understood and the answers corrected.

(19) The same ten lotteries were used in all three cases. Within each case, however, the lotteries were randomized for each player to avoid influences from ordering.

(20) See Table 1 for the prices, probabilities, expected value per token, and variance per token of the ten lotteries for both the base and nonbase crop.

(21) These lump-sum payments are calculated with all acres eligible for DPs and CCPs (they do not include adjustments for payment acres or payment yields). In practice, CCPs cover only a portion of the shortfall between the target price and the effective price (market price plus direct payment) since payments are made on 85% of base acres times a historical yield. DPs are also subject to payment acre and yield adjustments. Recall we assume no marketing loan program.

(22) Setting BONUS1 at 1.50 lab dollars/acre made DPs 10% of the income receive from the target price. Direct payments rates in the 2002 Farm Act range from 1.71% (Oats) to 22.4% (Rice) of the target price, with a mean of 10.9% (Westcott, Young, and Price 2002).

(23) Consider the possibilities of the realized Blue prices: (a) If the price is the High Price, the participant receives the market price (at least 17 per token, see Table la) plus the direct rate (1.5 per token) which, in sum, is greater than the target price per token. (b) If the price is the Low Price. the participant receives the market price plus the direct rate plus BONUS 3 which, in sum, is the target price per token (1,500 total lab dollars divided by 100 tokens equals the target price of 15 per token). (c) If the price is the Zero Price, the participant receives a market price of zero plus the direct rate plus BONUS 2 which, in sum, is again the target price per token (1,500 total lab dollars divided by 100 tokens equals the target price of 15 per token). Thus the minimum received from a token allocated to the Blue option is the target price. The minimum possible earnings for investment in Red occurs when the realized Zero Red price and a realized High Blue price occur: (a) If the price is the Zero Price and the Blue price is High, the participant receives a zero market price plus the direct rate (1.5 per token) only (no bonuses when blue price > target price) which, in sum, is equal to 1.5 per token. Thus the minimum received from a token allocated to the Red option is the direct rate.

(24) Recall under the mandatory base update outcome, blue remains a program or base crop, and red remains ineligible for bonus payments.