For the undergraduate students of the course: Ag. Econ. 6.4 Farm Management, Production and Resource Economics (2+1) of Junagadh Agricultural University, Gujarat and other SAU's in India.

1. Lecture 19 : Risk and Uncertainty

2. Risks and Uncertainty: Definition
• Risk is a situation of perfect knowledge where all possible outcomes are known for a
given management decision and the probability associated with each possible
outcome is also known.
• Risk is measurable thereby insurable.
• Uncertainty refers to those situations of imperfect knowledge that exist when:
(i) all possible outcomes are unknown;
(ii) the probability of the outcomes is unknown; and
(iii) both outcomes and the probabilities are unknown.
• Uncertainty cannot be measured thereby cannot be insured.
• Risks are measured through probability concepts.
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3. Examples for risk and uncertainty:
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Particular Risk Uncertainty
Knowledge Perfect knowledge Imperfect knowledge
Outcome Known Not known
Probability Known Not known
Measurement Measurable Not measurable
Insurance Insurable Not insurable
Example Incidence of pest and
diseases (negative)
 Shortfall in rainfall (negative)
 Fixed capital
investments (positive)
Monsoon failure / drought
(negative)
Implications of Chinese
Corona Virus (COVID-
19) pandemic
Outbreak of Avian flu
 Technology uncertainty

4. Risk terminologies
• Issue: A risk which has already occurred is considered an issue.
• Opportunities: Positive risks are called opportunities. A farmer
has to take advantage of such positive risks.
• Risk appetite: Amount and type of risk that a farmer is prepared
to seek, accept and tolerate.
• Risk tolerance: Farmers’ readiness to bear the risk treatments in
order to achieve his objectives.
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5. Risks and Returns
A risk is always associated with future course of events
• Greater the risk greater would be the return.
• A risk without any return is a suicide.
• Risk can be minimized but not totally eliminated
• Risk can be managed and be kept at a lower side.
• Risks are not inherently bad as they are often associated with
profits.
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6. 6
Why risk arises in agriculture?
Risks are always omnipresent in agriculture due to the following factors:
1. Dependence on Nature (Production Risk)
2. Human Elements (Human/Personal Risk)
3. Markets (Price Risk / Market risk)
4. Government rules and regulations (Institutional Risk)
5. Financial Matters (Financial Risk)
6. Business risk (Aggregate of all the risks combined, except financial)
Sources of risks in agriculture:

7. 1. Production risk or technical risk
• Weather risk and technical risk are the two major components of
production risk.
• Changes in weather conditions leading to changes in production is called
as weather risk.
• With the changes in technology, there may be greater variations in output.
This is called as technical risk.
Example:
- Insect-pest attacks
- Vagaries of monsoon
- Breakage / non-functioning of farm machinery at crucial times
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8. 2. Human risk or personal risk
• Farmers / farm labourers who operate the farm may become a
source of risk to the farm profitability itself.
• E.g.: Prolonged illness / death /non-availability of labourer/ key
management employee or labour strike
• Disputes at farm or within farming families leading to the
disruption of farm work.
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9. 3. Price risk or Market risk
• Changes taking place in the markets (for both input supplies and
output sale) may become a source of risk for the farmer.
• E.g.: Price fluctuations and availability of inputs like labour,
seeds, fertilizer, plant protection chemicals, plant growth
promoters, etc.
• Volatility in output prices of both main product and by-product are
also a case of price risk.
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10. 4. Institutional risk
• Changes in government rules and regulations or policy orientation becomes a source
of risk.
Example: 50 IRS officers proposing ‘uncalled’ 40 %+ tax and COVID-19 cess on
>10 lakh per annum earners on 25/04/2020– creating panic amid the pandemic.
Other examples:
Ban of export of agril. commodities (like wheat)
Restricting movement of agricultural produce
Imposing levy on certain commodities
Acreage restrictions / Quantitative restrictions
Ban on production in some regions
Restrictions intended for resource utilization (like groundwater conservation)
Subsidy and taxation changes.
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11. 5. Financial risk
• Financial risks increases with increased amount of borrowed money
for farm business activities.
• Financial risks may arise due to:
Changes in rate of interest
Changes in institutional policy regarding lending to a particular
crop / enterprise
Changes in repayment plans drawn by banks
Non-institutional lenders forcing to make repayments in kind rather
than cash.
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12. 6. Business risk
• Aggregate effect of {production + market + institutional risks} is
called as business risk.
• It is the aggregate effect of all the risks influencing the
probability of the firm.
• Business risk is the risk faced by the firm independent of the way
in which it is financed. Hence, financial risk is not part of it.
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13. What is risk management?
• Risk management refers to the identification, assessment, and
prioritization of risks (positive or negative) followed by
coordinated and economical application of resources to
minimize, monitor, and control the probability and / or impact
of unfortunate events or to maximize the realization of
opportunities.
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14. Risk Management Strategies
• Risk Mitigation: Actions taken to eliminate or reduce events
from occurring, or reduce the severity of losses (e.g. water
draining intervention, crop diversification, etc.)
• Risk Transfer: Actions that will transfer the risk to a willing
third party at a cost resulting in either full compensation or
reduction in risk generated loss (e.g. insurance)
• Risk Coping: Actions that help to cope with the losses caused
by a risk event (e.g. government assistance, debt re-structuring)
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15. Methods of Risk Management
• 1. Retain: - take the risk – push the envelope; make no
protective arrangements (e.g. storing the produce instead of
immediate selling)
• 2. Shift: - sell it off / insurance – Usually the one who holds the
commodity bears the risk. Hence, it is better to dispose off the
commodity at the earliest. Insurance may shift a part of or
entire production risk from the farmers. Even contract farming
would shift a part of the risk to the contractor.
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16. • 3. Reduce: - prevention is always better – so usage of good
agricultural practices may help in reducing the risks. For e.g.:
•  Intercropping (diversification)
•  irrigation
•  selection of resistant varieties
•  securing marketing contracts
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Methods of Risk Management (Contd.)

17. • Self insure: - save for the rainy day – by keeping emergency
reserves from previous year’s savings / profits to mitigate
losses.
• Avoid: - play it safe – by not selecting a particular enterprise
not pushing the planting window; not increasing debt-asset
ratio, declaring a crop holiday, etc.
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Methods of Risk Management (Contd.)

18. Measurement of Risks
• Measuring the risk makes it possible to establish the institutions and protective
mechanisms for mitigation.
• Risk = Consequence X Probability X Exposure
• Probabilities can be attached to each event that can occur in a risky environment.
• Consequence of each event must be known i.e. either profit or loss.
• Exposure is the magnitude of loss / benefit that is likely to accrue to the firm.
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There is no risk when:
1. Weighted average > simple average
2. Expected yield > average yield.
3. Lowest range and lowest variance

19. 19
Weighted Average >
Simple Average
There is no price
risk for the
underlying
commodity
1. Estimating weighted averages:

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If expected value of yield is more than that of average
yield, then there is no yield risk.
2. Estimating expected values:

21. 3. Using variability to select less risky enterprises
• Selection of enterprises on the basis of small range and lowest
variance.
• Range: Measure of variability and it is the difference between
lowest and highest possible outcomes.
• Variance: It is the average of squared differences / deviations
from the mean of the underlying variable.
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22. Methods of reducing risks in farming
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1. Diversification
2. Stable enterprises
3. Crop and livestock insurance
4. Flexibility
5. Spreading sales
6. Hedging
7. Contract farming
8. Minimum Support Prices
9. Increasing Net-worth

23. Define:
1. Risk
2. Uncertainty
3. Business risk
4. Risk management
5. Risk transfer
6. Institutional risk
7. Hedging
8. Price risk
Write briefly:
1. Sources of risks in agriculture.
2. Risk management strategies
for agriculture.
3. Risk measurement
4. Methods of risk management
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Self-Assessment: