ECONOMIC INEFFICIENCY UNDER UNCERTAINTY AND THE EFFECTS OF IDEAL RISK MARKETS IN U.S. AGRICULTURE (INCOMPLETE MARKETS, GOVERNMENT INTERVENTION, WELFARE, UNITED STATES)

This study is motivated by concern about the level of assistance historically provided to U.S. farmers and the frequency with which this assistance is justified by arguments that agriculture is more unstable and risky than most other sectors. There are four objectives: (a) To set out systematically the conditions under which instability and risk lead to market failure and economic inefficiency in agriculture; (b) To develop an analytical framework for investigating the importance of incomplete risk markets as a source of economic inefficiency in agriculture; (c) To undertake an empirical test for the existence of ideal risk markets in U.S. agriculture; and (d) To provide quantitative estimates of price, output and economic welfare changes when ideal risk markets are introduced, compared to a situation in which there are no risk markets at all available.;Results indicate that net welfare gains from ideal risk markets are small in percentage terms. The conclusion is that efficiency gains are possible from government intervention when risk markets are incomplete but benefits and costs of particular policies must be evaluated on a case by case basis. Perhaps surprisingly, it is also found that farmer welfare is actually lower in the ideal equilibrium than when no risk markets at all are available.;Empirical evidence on whether a complete set of ideal risk markets is available in U.S. agriculture is provided from maximum likelihood estimates of a restricted vector autoregression. The restrictions are derived from a representative farmer model of the decision to store grain. Previous evidence is also discussed and the conclusion is that farmer behavior is inconsistent with the existence of a complete set of ideal risk markets.;The analytical framework highlights the role of risk markets in the efficiency of market economies. The importance of incomplete risk markets as a source of inefficiency in agriculture is investigated by comparing two polar cases: a rational expectations equilibrium in which no risk markets are available and an "ideal" rational expectations equilibrium in which all conceivable risks can be insured on available risk markets. Under suitable restrictions on preferences and technologies a closed form analytical solution to the model is obtained and quantitative comparisons of the two equilibria are undertaken.