Presentation is loading. Please wait.

Presentation is loading. Please wait.

Flat-earth economics Far-reaching consequences of flat payoff functions David Pannell University of Western Australia.

Similar presentations


Presentation on theme: "Flat-earth economics Far-reaching consequences of flat payoff functions David Pannell University of Western Australia."— Presentation transcript:

1 Flat-earth economics Far-reaching consequences of flat payoff functions David Pannell University of Western Australia

2 Starting point  1983

3 Payoffs  profit  expected value of profit  expected utility  any other objective function that has an internal optimal solution

4 Example: whole farm plan 51% 92%

5 Example: herbicide dose

6 Monopolist’s pricing decision

7 Jardine (1975): “On presenting information to agronomists about flat profit curves for fertlizers, I observed such reactions as complete disbelief, blank incomprehension, incipient terror, and others less readily categorized.”

8 Flat payoff functions are:  A consistent empirical finding (almost universal)  Very important  Rarely acknowledged  Debated in 1975, but apparently not since

9 What is behind it?

10  Diversified portfolios  e.g. because of  risk aversion  variable resource quality  resource constraints  complementarity between enterprises

11 Implications

12 Implication 1: Margin for error  Decisions without careful analysis  Can consider extra factors  Risk  Personal preference  DSSs  focus on plateau, not optimum

13 Implication 2: The value of monitoring  Sustainability indicators/EMS  The value of information  decision theory framework  What difference to the decision? information   decision  What difference then to payoff?  decision   payoff  Weighted by probabilities  Value often low

14 Implication 2: The value of monitoring  If payoff function is flat:  Info may change decision  But not change payoff by much

15 Implication 2: The value of monitoring  If payoff function steep  Optimal solution obvious  More info doesn’t change it Either way, low info value

16 Implication 3: Precision farming  Jock Anderson (1975):  "In pursuing optimal levels of decision variables, precision is pretence and great accuracy is absurdity."

17 Implication 3: Precision farming  Example: lime application for acidity  Very low precision: same low rate for all  Low precision: rate set for each soil type for each region  Moderate precision: paddock by paddock  (High: adjust within paddock)

18 Example: liming acidic soils Typical payoff function

19 Implication 3: Precision farming Value of information $/ha from greater precision of info Change from moderate to high  0  0 0

20 Implication 4: Value of research  Consider two types of research  increases the yield of a crop by 20% (increases yield directly)  provides info that yield will be 20% higher than previously believed (increases yield indirectly through adjustments to input levels)  Which is more valuable?

21 Implication 4: Value of research Value of improving technology = P2,2 - P1,1 Value of improving information = P2,2 - P1,2

22 Implication 5: Risk

23  Accounting for risk aversion makes a small difference to payoffs (CE or U)  Example: herbicides again

24 Example: herbicide dose R=0 R=3.2

25 A non-implication: Externalities  “Surely, if you consider externalities, the point breaks down!”  payoff function stops being flat  input level starts to really matter

26 Externality doesn’t change story 90% range

27 Externality doesn’t change story

28

29 Conclusion  Flatness far more important than optimum  Should emphasise flatness and its implications  to our students  to our clients  to ourselves

30 Conclusion  Implications include  Margin for error/Flexibility  Low value of monitoring  Diminishing marginal value of precision  Research: value of new technology greater than value of new information  Risk aversion not very important in normative studies

31 Pannell, D.J. (2006). Flat-earth economics: The far-reaching consequences of flat payoff functions in economic decision making, Review of Agricultural Economics 28(4):


Download ppt "Flat-earth economics Far-reaching consequences of flat payoff functions David Pannell University of Western Australia."

Similar presentations


Ads by Google