2024 – A corn farmer is considering two alternatives for selling his crop The first

A corn farmer is considering two alternatives for selling his crop. The first is

a contract where he can sell the rights to the future crop at planting. The second

is to sell the crop after harvest. At harvest the farmer estimates that the price of

corn will be $10 per bushel with probability .5 and $12 per bushel with

probability .5. The farmer is averse to risk, and is willing to pay $50,000 to avoid

the risk of damage to the crop while it is growing (e.g., from a tornado or flood).

If the farmer uses pesticides he expects a crop of 60,000 bushels; if he does not

use pesticides he expects a crop of 55,000 bushels. The cost of pesticides is

$20,000. The other costs associated with planting and harvesting the crop total

$450,000.

a. If the farmer decides to sell the crop at harvest will he be better off using

pesticides or not using them? What is the farmer’s expected profit in each case?

b. What is the maximum a purchaser would be willing to pay to the farmer for

the rights to the future corn crop assuming they cannot monitor the farmer after

purchasing the contract? Defend your answer.

c. Which alternative: (1) sale of rights prior to planting or (2) selling the crop

after harvest yields the maximum expected benefit for the farmer considering

his level of risk aversion?