Tuesday, July 26, 2016

Member Blog: David Zilberman

Agricultural economics as behavioral economics

July 23, 2016
Behavioral economics is perhaps the most important new paradigm in economics in the new millenium. It is based on the idea that people don’t behave rationally, like economics suggests – that they are, in Thaler’s words, Humans (homo sapiens) rather than Econs (homo economicus).

In the 1960s and 1970s, Nobel Laureate Herbert Simon and others developed behavioral economic theories assuming that people satisfy rather than maximize their profit or utility and that their rationality is bounded (i.e. confined). But the foundation for modern behavioral economics came in the 1980s, with Prospect Theory developed by Kahneman and Tversky to explain behavior under risk. While modern behavioral economics is changing the way economics and finance are practiced and which policies are introduced, agricultural economics have integrated behavioral elements into their models and practices since the 1960s. And some of these elements actually became part of mainstream economics.

Agricultural economics originated in two fields: farm economics and farm management. Farm economics was standard economics applied to production and markets of food. Farm management aimed to guide farmers how to make choices, and therefore needed to deal closer with reality, with farmers who are really Humans not Econs. Here I’d like to present some of the behavioral elements that emerged in agricultural economics.

First, decision making under risk has been a major topic of agricultural economics. One of the big challenges of agricultural economists is understanding why farmers didn’t adopt technologies that were shown to have higher yields and profits than traditional practices, especially during the Green Revolution. What agricultural economists realized is that farmers were concerned about risk, especially downside risk. Namely, they would not adopt a technology that doubles yield on average, but during droughts, that may occur 10% of the time, produces much lower yields than the traditional technology. Therefore, agricultural economists applied approaches like ‘safety first’ (where a farmer would say “I’d rather avoid a disaster than increase my average yield”) or similar methods where most of the weight in technology choice is given to avoiding significant setbacks. This extra attention to losses compared to gains is close in many ways to the notion of ‘loss aversion,’ a key element of Prospect Theory that is promoted by behavioral economists to replace the neo-classical ‘expected utility’ approach to address risky choices. Much of the insights of behavioral economics originated from hypothetical and real-life experiments and such experiments are likely to play a major role in the future. Agricultural economists were probably among the first to conduct field experiments where farmers, in India, were given money under various conditions and assessed their risk preferences, and found results that challenged existing expected utility approach.

Read the entire blog post here: http://blogs.berkeley.edu/2016/07/23/agricultural-economics-as-behavioral-economics/

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