Enterprise diversification in US dairy: impact of risk preferences on scale and scope economies

Abstract

Enterprise diversification has recently become a prominent feature of US dairy farms. Scope economies and risk aversion are two forces that simultaneously determine diversification. We jointly estimate scope economies and determine risk preferences under price uncertainty. We reject risk neutrality in favour of Increasing Absolute Risk Aversion (IARA) and Increasing Relative Risk Aversion (IRRA). Scope economies are significant, but diminish with farm size. Increasing returns to scale exist in the production of multiple enterprises and diminish with size. Large farms operate under decreasing returns to scale. Ignoring risk preferences, a common practice in empirical work, results in an underestimate of the effect of scope economies for large farms.

Farm‐level determinants of product conversion: Organic milk production

“…This result is consistent with Melhim and Shumway (2011), and varies slightly with Skolrud and Shumway (2013) and Mosheim and Lovell (2009), who find evidence of significantly increasing returns to scale at the mean using their preferred specification. This result is consistent with Melhim and Shumway (2011), and varies slightly with Skolrud and Shumway (2013) and Mosheim and Lovell (2009), who find evidence of significantly increasing returns to scale at the mean using their preferred specification.…”

“…Note: The red line is a beta distribution that has been fitted to the histogram of technical efficiency estimates not significantly different from one, suggesting that constant returns to scale cannot be rejected at the data means. This result is consistent with Melhim and Shumway (2011), and varies slightly with Skolrud and Shumway (2013) and Mosheim and Lovell (2009), who find evidence of significantly increasing returns to scale at the mean using their preferred specification. Figure 2 presents histograms and fitted normal distributions for returns to scale estimates estimated from the BCF (left panel) and TL (right panel).…”

“…In their study using ARMS farm-level data from the year 2000, Mosheim and Lovell (2009) find that increasing returns to scale exist over all farm sizes in the survey. Melhim and Shumway (2011) are the only exception. 6 Even for large farms with herd sizes of at least 2,000, the long-run scale elasticity is still 1.25, indicating that average costs can still be diminished by increasing the scale of operation.…”

“…Tauer and Mishra (2006) and MacDonald et al (2006) report evidence of a declining average cost curve, and Skolrud and Shumway (2013) report nondecreasing returns across multiple farm sizes (mean 1.32, 95th size percentile 1.03). Melhim and Shumway (2011) are the only exception. Using ARMS data from the year 2000 and considering risk as well as profit as arguments in their utility function, they report evidence of significantly decreasing returns to scale for the largest 10% of farms.…”

“…We specifically address the role of TE, returns to scale, output diversification, and elasticities of substitution between inputs restricted by the organic standards and their substitutes as potential drivers of conversion to organic milk production. The focus on TE and returns to scale is warranted by current trends in the U.S. conventional dairy sector, where research has documented the existence of nondecreasing returns to scale across nearly all farm sizes (Melhim & Shumway, 2011) and the significance of returns to scale in driving industry consolidation (Mosheim & Lovell, 2009). Further, capital and input requirements mandated by organic restrictions may act as a source of diseconomies of scale, creating an adoption advantage for conventional farms that have yet to meet the minimum efficient scale in the conventional industry.…”