Spatial Production Concentration under Yield Risk and Risk Aversion

A study of equilibrium acreage allocation decisions at the farm and regional levels under risk aversion, yield uncertainty, and endogenous crop prices is undertaken in a two-crop, two-region setting. The main insight is that a partial specialization in one crop at a regional level may be an equilibrium dominant strategy relative to the more diversified crop mix produced on farm. This is due to the trade-offs among the effects of the “natural hedge” based on the negative price-yield correlation on the probability distributions of crop revenues and whole-farm revenue risk reduction through crop enterprise diversification. Another finding is that equilibrium in which each region grows only one crop is unlikely unless there are comparative advantages in production (or marketing) across regions. Other circumstances under which complete regional specialization is possible include a high level of producer risk aversion along with limited benefits derived through crop enterprise diversification due to high correlation of farm-level yields for different crops, and a low crop price elasticity. This applies to situations in which one can identify growing regions that are possessed of two features. The first feature is that growing conditions are relatively homogenous and farmlevel yield co-variability is higher within each region as compared with that across the regions. The second feature is that the sizes of the regions are large enough to have a substantial impact on output prices.