Politics and dryland salinity

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Flat-earth economicsFar-reaching consequences of
flat payoff functions
David Pannell University of Western Australia
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Starting point

• 1983

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Payoffs

• profit
• expected value of profit
• expected utility
• any other objective function that has an internal
  optimal solution

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Example whole farm plan
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Example herbicide dose
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Monopolists pricing decision
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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.
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Flat payoff functions are

• A consistent empirical finding (almost universal)
• Very important
• Rarely acknowledged
• Debated in 1975, but apparently not since

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What is behind it?
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What is behind it?

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

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Implications
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Implication 1Margin for error

• Decisions without careful analysis
• Can consider extra factors
• Risk
• Personal preference
• DSSs
• focus on plateau, not optimum

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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

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Implication 2 The value of monitoring

• If payoff function is flat
• Info may change decision
• But not change payoff by much

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Implication 2 The value of monitoring

• If payoff function steep
• Optimal solution obvious
• More info doesnt change it

Either way, low info value
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Implication 3 Precision farming

• Jock Anderson (1975)
• "In pursuing optimal levels of decision
  variables, precision is pretence and great
  accuracy is absurdity."

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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)

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Example liming acidic soils
Typical payoff function
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Implication 3 Precision farming
Value of information /ha from greater precision
of info
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Implication 4Value 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?

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Implication 4Value of research
Value of improving technology P2,2 - P1,1 Value
of improving information P2,2 - P1,2
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Implication 5Risk
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Implication 5Risk

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

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Example herbicide dose
R3.2
R0
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A non-implicationExternalities

• Surely, if you consider externalities, the point
  breaks down!
• payoff function stops being flat
• input level starts to really matter

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Externality doesnt change story
90 range
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Externality doesnt change story
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Externality doesnt change story
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Conclusion

• Flatness far more important than optimum
• Should emphasise flatness and its implications
• to our students
• to our clients
• to ourselves

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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

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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) 553-566.
www.davidpannell.net