Cost economies in the presence of marketing contracts

Abstract

We examine the impact of marketing contracts on farm cost structure and implied scale and scope economies for large samples of dairy, corn and wheat farms. We consider a multi-product, multi-market technology to examine returns from diversifying marketing schemes. Allowing for risk preferences under price uncertainty, we estimate the contract adoption decision, risk preferences and structural parameters simultaneously. We derive measures of economies for both contracting and noncontracting farms. Each industry exhibits significant scope and multi-output scale economies but vary in product-specific scale economies. We find that marketing contracts improve returns to corn and wheat farms, but not to dairy farms.

Keywords:

• marketing contracts
• scope economies
• scale economies
• market diversification
• farm growth

JEL Classification::

• Q12
• Q13

Acknowledgements

This research was supported by the Washington Agricultural Research Center, by the USDA Economic Research Service (grant no. 109252-001), and by the USDA Cooperative State Research, Education and Extension Service (Hatch grant no. WPN000275).

Notes

¹ Farms specialized in producing under marketing contracts, although conceptually important, are not included in our comparison because they are not common in practice for these industries.

² The small number of dairy farms that produced crops under marketing contracts would create confidentiality concerns if that option were included in the analysis. To avoid bias in the estimation of livestock contracting, these observations were dropped from the sample.

³ We do not include the third input equation as part of the estimation system because of the additional computational burden when this quadratic equation is included. All parameters of the missing input demand equation can be recovered from this estimation system.

⁴ Convexity of the cost function in output quantities is equivalent to convexity of the indirect utility function in output price moments.

⁵ Additional results related to the spot market price moments in Equations 7 and 8 and the contracting decision in Equation 9 are available in the Reader's Supplement on request.