Bulletin 593 January, 1953
So, 0o 0;2- 49EL
in Farm Management
By Glenn L. Johnson and Cecil B. Haver
Kentucky Agricultural Experiment Station
University of Kentucky Lexington
(Note: This bulletin was prepared under the sponsorship of the North Central Farm Management Research Committee but is published by the University of Kentucky and is not numbered in the regional series.)
NORTH CENTRAL FARM MANAGEMENT RESEARCH COMMITTEE
CLIFFORD M. HARDIN, Michigan Agricultural Experiment Station
J OSEPH ACKcERMAN, Farm Foundation, Chicago, Illinois
Illinois P. E. JOHNSTON, University of Illinois,
Indiana LYNN S. ROBERTSON, Purdue University
Iowa EARL 0. HEADY, Iowa State College
Kansas J. A. HODGES, Kansas State College
Kentucky GLENN L. JOHNSON, University of Kentucky
Michigan KARL VARY, Michigan State College
Minnesota GEORGE A. POND, University of Minnesota
Missouri 0. R. JOHNSON, University of Missouri
Nebraska A .W. Epp, University of Nebraska
North Dakota CECIL B. HAVER, North Dakota Agricultural
Ohio 1. FALCONER, Ohio State University
South Dakota RUSSELL BERRY, South Dakota State College
Wisconsin P. E. McNALL, University of Wisconsin
United States Department of Agriculture, Cooperators Bureau of Agricultural Economics C. W. CRICRMIAN. Washington, D. C.
RUSSELL 0. OLSON, Ames, Iowa
While prepared under the sponsorship of the North Central Farm Management Research Committee, this bulletin is, in part, a contribution under RMA 42, XKentuCky Agricultural Experiment Station, and also, in part, a contribution under Purnell 142, North Dakota Agricultural Experiment Station. Acknowledgement is extended to the other members of the Risk and Uncertainty Subcommittee Russell Berry, Earl 0. Heady, and J. A. Hodges, as well as to other members (particularly Lynn Robertson and 0. R. Johnson) of the over-all Committee, for. their constructive criticisms. Clifford Hildreth, University of Chicago, and P. J. Thair, Bureau of Agricultural Economics, also made valuable basic criticisms.
The manager of a farm, or any business, continuously is forced to make decisions that affect the welfare of his business. He makes such decisions with varying degrees of certainty or uncertainty as to what the outcome will be. In this publication, the authors have outlined the various situations under which a manager makes decisions, and have developed sets of principles to guide him.
The farmer, student, or teacher who studies this bulletin will have a greater appreciation of the role of the manager. He will understand to a greater degree why some people are successful managers and why some are apparently unsuccessful. Likewise, he should be able to sharpen his own mental processes and, as a result, be able to make decisions that are more nearly satisfactory to him and to his business.
The study that resulted in this bulletin is part of a program of research developed by the North Central Farm Management Research Committce. It was prepared by Professor Glenn Johnson of the Kentucky Agricultural Experiment Station, and Professor Cecil Haver of the North Dakota Agricultural Experiment Station, with the advice and counsel of other members of the regional committee.
Appreciation is due the Kentucky Agricultural Experiment Station for publishing the bulletin and consenting to make copies available to other states.
CLIFFORD M. HARDIN
TABLE OF CONTENTS
O b jectives ............................................................................................ 5
Introductory Discussion .......................................................................... 5
Problems W ith W hich Managers Must Deal .......................................... 8
Knowledge Situations ............................................................................ I I
Subjective Uncertainty .................................................................. I I
Subjective Risk Situation ................................................................ 13
Subjective Certa i nty- Appa rent ly Perfect Knowledge .................... 13
Discussion of the Knowledge Situations .... : ............................................. 13
Examples of How Managerial Principles Are and Can Be Used in
Handling Change and Imperfect Knowledge .............................. 14
C oncern ing P rices ........................................................................ 14
Concerning Production M ethods .................................................... 19
Concerning New Developments and Inventions .............................. 22
Concerning Human Behavior and Capacities ................................ 27
Concerning Institutions .................................................................. 30
M iscellaneous Examples ................................................................ 31
Summary of Principles and Generalizations ............................................ 32
Principles and Generalizations Having To Do W ith Learning .......... 33
Strategy and Generalizations of Use in Deciding How Much
Chance to Take ...................................................................... 34
Some Psychological Patterns Concerning the Value of Gains and
L o sses ...................................................................................... 3 7
Su m m a ry .............................................................................................. 3 8
in Farm Management
By GLENN L. JOHNSON and CECIL B. HAVER1
In view of the rapidly developing managerial principles for handling situations involving change and imperfect knowledge, the following objectives are sought in this bulletin:
(1) To summarize and bring to the attention of farm managers,
research workers, and extension men some of the decisionmaking principles that have been developed.
(2) To discuss and illustrate in a semipopular form the usefulness
of such principles to farmers.
(3) To set up classifications of (a) farm management problems
and (b) degrees of knowledge farmers have about problems.
(4) To provide a bibliography for those interested in delving
further into the logic of the principles presented.
Change Is normal; partial ignorance is universal
The most characteristic aspects of farming operations are (1) the changes that continually occur, and (2) the lack of knowledge concerning conditions that affect individual businesses. Prices, what individual farmers know about production processes, production techniques, weather, health, and governmental arrangements change continuously. Instability appears to be more characteristic than stability. Farmers continually try to improve their knowledge of the conditions that affect their businesses. In fact, lack of knowledge is as normal as change; partial ignorance is universal.
Between 1932 and 1948, the over-all index of prices received I Glenn L. Johnson, Kentucky Agricultural Experiment Station, and Cecil B. Haver, North Dakota Agricultural Experiment Station.
6 BULLEFIN No. 593 [Jan.,
by United States farmers for the items they sell fluctuated between 65 and 285 percent of the level that existed in the 1910-14 period. For a typical family-operated, grain-roughiage-livestock farm in the Northern Plains, prices received between 1932 and 1945 varied from 40 to 185 percent of the 1930-44 average. On a typical hogdairy farm in western Illinois, a similar index of prices received ranged from 51 to 182 percent of the same average. Similarly, prices received on a typical, family-operated dairy farm in southern Wisconsin varied from 55 to 188 percent of the 1930-44 average.
Changes in the prices of farm products in relation to each other have been no less important. In 1933, prices for meat animals were almost twice as high relative to hay and feed grain prices as in the 1935-39 period. In 1943, prices of oil-bearing crops were almost three times as high as prices of food grain and more than twice as high as prices of meat animals in the 1935-39 period. The importance of such changes ini relative prices is readily apparent to anyone acquainted with farms producing wheat, pork, beef, soybeans, flax, or corn.
From 1929 to 1949, in the United States as a whole, the yield of wheat per acre harvested ranged from a low of 11.2 bushels in 1933 to a high of 18.4 bushels in 1947. Similarly, U. S. average corn yields ranged in 1929-49 from a low of 15.7 bushels per acre in 1934 to a high of 42.8 in 1948. In milk production, yields are much more stable. However, from 1930 to 1949, production per cow for the United States as a whole ranged from a low of 4,000 in 1934 to a high of 5,200 pounds in 1949. These national averages cover up much of the variation in yield experienced by individual farmers.
Those familiar with agriculture know of the changes that continually occur in production techniques. In the last few years, hybrid corn, new insecticides such as DDT, new herbicides such as 2-4D), antibiotics, improved roughage-handling equipment, and many other improvements have come to United States agriculture and have had their impacts upon individual farm businesses. Farmers are continually improving the degrees of knowledge they possess concerning production techniques.
Also, in the past few years, widespread changes have occurred in government programs that affect farmers. Farmers have had to learn about and to adjust to acreage controls, marketing agree-
1953] DECISION-MAKING PRINCIPLES 7
ments, price supports, draft laws, and an altered, heavier structure of state and federal taxes.
Agriculture in the United States is perhaps the most complex in the world. It uses complex production techniques in producing products priced in complex national, international, and local markets. Further, the people with whom farmers deal present a wide variety of characteristics due to divergent training, and backgrounds. Not the least important of the complexities that face our farmers are the economic, political, and social institutions of the nation. Consider for a moment the private and public credit institutions, the impacts of war and wartime economic controls, marketing arrangements, government price and production-control programs, tenure arrangements, and the various bodies of federal, state, and local laws. An individual farmer can hardly have complete knowledge of these complex conditions affecting his business.
These changes (and sources of imperfections in knowledge) merely illustrate the nature of some of the problems faced by farmers of the United States and, more particularly, of the North Central Region.
Adjustment to change and improvement in knowledge is of first importance'
With change and imperfect knowledge2 obviously so important, farmers must continually learn and adjust.3 As a consequence, they must spend time learning and making decisions on the basis of what they learn.4 The essence of management is the process of learning and adjusting.5
The jobs of management
Managers must observe, analyze, and make decisions. But these are not the only functions they perform. In addition, they act on
IT. W. Schultz, "Theory of Firm and Farm Management Research," Journal of Farm Economics, 21:570-86, 1939.
The terms imperfect knowledge, lack of knowledge, ignorance, and incomplete information are used synonymously and interchangeably in this bulletin.
I F. H. Knight, Risk, Uncertainty, and Profit, Houghton-Mifflin, New York, 1921.
'A. G. Hart, "Risk, Uncertainty, and Unprofitability of Compounding Probabilities," pp. 110-18 in 0. Lange, et al. (ed.) Studies in Mathematical Economics and Economeirics, University of Chicago Press, Chicago, 1941.
The adjustment process also extends to one's stock of knowledge: it is often advisable to discard or to forget past accumulations of knowledge as other types of knowledge become relatively more important.
8 BULLETIN No. 593 [Jan.,
the basis of their conclusions and accept at least partial individual economic responsibility for the actions they take.' Farm managers also perform still other functions, laboring as well as coordinating and supervising. But the essential difference between performing these functions, as contrasted with the management functions defined herein, is that the manager performs or has the opportunity to perform the following five functions:
(3) decision concerning the problems under consideration2;
(5) acceptance of economic responsibility.
These are the five functions that a manager, operating in the presence of continuous change, and only partly informed, must perform if he is to chart successfully the course of his business over a period of time.
Problems With Which Managers Must Deal
Five broad subject-matter areas (categories) which managers must study, as a basis for adjustment, can be distinguished. Although these categories do not necessarily cover every kind of change and imperfection in knowledge that might affect a farm business, they do cover the important situations with which farm managers must deal. These five categories are:
(1) price structures and changes;
(2) production methods and responses (including weather effects);
(3) prospective technological developments;
(4) the behavior and capacities of people associated with farm
'Of course, people bear all sorts of responsibilities other than economic. The term economic is relatively broad when interpreted, as it is by the authors, to include both monetary and subjective values.
2 As distinguished from the series of analytical decisions in the thought processes leading up to this terminal decision.
3The functions of decision-making and action-taking are closely interrelated. It can be argued, for instance, that no decision is final until expressed in terms of an action. It is obvious that a deciding process not terminating in action may lead to a different decision, this being the basis for including action-taking and acceptance of economic responsibility as a job of management.
1953] DLCISION-MAKING PRINCIPLES 9
(5) the economic, political, and social situations in which a farm
Lack of knowledge concerning price structures and changes2
A farmer's knowledge is almost always imperfect with respect to the prices hie will receive for the products he produces and the prices hie must pay at future dates for items used in production and consumption. Economists, farmers, and businessmen all experience great difficulty in foreseeing long-run changes in the level of prices. Relationships between prices are usually more stable and hence somewhat easier to predict than the level of prices. For instance, the hog-corn ratio or the dairy-feed price ratio is more easily predicted and handled than are the absolute levels of hog, corn, milk, and dairy-feed prices.
Imperfections in knowledge concerning production techniques and production responses
Farmers are usually interested in learning more about existing methods of producing a particular product. Frequently their productive "know-how" can be changed by learning something about existing production techniques. Similarly, knowledge about expected production is never perfect in agriculture; weather and biological factors such as disease and parasitic infestations often result in production responses that differ widely from those anticipated by a farmer in planning his production programs.
I It may lbe noted (1) that the first two of these subject-matter areas, prices and production methods, are the traditional fields of interest of farm-management men andI static-production economists, (2) that the third area- technological change-was a special field of interest of Schumpeter with his interest in innovations, (3) that the fourth field, human behavior, is roughly the special field of interest of von Neumann and Morgenstern with their interest in the theory of games and personal strategies, anti (4) that the fifth area, economic, political, and social institutions, is the special field of interest of the institutional economists.
I D. Gale Johnson, Forward Prices for Agriculture, Chicago: University of Chicago Press, 1947.
W. AV. Wilcox, "Effects of Farm Price Changes on Efficiency in Farming," Journal of Farm Economsics, 33:55-65, 1951.
D. B. Williams, "Price Expectations and Reactions to Uncertainty by Farmers in Illinois," Journal of Farm Economics, 33:20-39, 1951.
IN. E. Hendrix, "Availability of Capital and Production Innovations on Low Income Farms," Journal of Farm Economics, 33:66-74, 1951.
Emily L. Day and E. L. Barber, Physical Risks in Farm Production Selected References, 1930/48, Library List No. 49, U. S. Dept. of Agriculture Library, August 1949.
10 BULLETIN No. 593 [Ja,.,
Ignorance concerning prospective changes in technology (production methods)'
An outstanding characteristic of agriculture in the United States is the rapid rate of progress in production methods. Competition is keen and failure to learn about and adopt production methods capable of reducing costs is often disastrous to the individual. New inventions and developments often render fixed investments obsolete; thus, managers are generally aware of the need to "keep up with developments."
Incomplete information concerning behavior and capacity of people associated with farm businesses2
A manager of a particular farm cannot have perfect knowledge concerning the personal performance, honesty, and capacity of himself, the people he hires, the people he does business with, and the members of his own family. Some farm businesses fail because a manager or his wife experience break-downs that reduce their physical and mental capacities. Any community will furnish examples of farm businesses that have been ruined by failure of various people to live up to expectations held by managers of the businesses. Conversely, any community will furnish illustrations of situations in which better-than-expected performance has resulted in outstanding farming accomplishments.
Lack of knowledge concerning economic, political, and social settings
Subsidy programs come and go. Tax structures change. Price controls and price supports are imposed and removed. A large business concern moves into a rural community and affects the demand for labor. War alters and changes the supply of and demand for farm products and the factors used in producing them. Such changes in the economic, political, and social setting have
I Hendrix, op cit.
1J. M. Brewster and H. L. Parsons, "Can Prices Allocate Resources in American Agriculture?" Journal of Farm Economics, 28:938-60, 1946.
J. D. Black, et al., Farm Management New York: The Macmillan Co., 1949, pp. 88-102.
J. von Neumann and 0. Morgenstern, Theory of Games and Economic Behavior Princeton: Princeton University Press, 1944.
J. McDonald. Strategy in Poker, Business and War New York: W. W. Norton and Company, 1950.
1953] DECISION-MAKING PRINCIPLES 11
heavy impacts on farm businesses that must be studied as a basis for adjustment.
The knowledge situations in which farm managers find themselves need to be classified as a basis for seeing more clearly how management handles problems of change and imperfect knowledge. Situations vary from those involving outcomes so imperfectly known that no action is willingly taken, to those in which anticipated outcomes are regarded as perfectly known.
Because managers continually try to add to their knowledge, it seems desirable to set up a classification of knowledge situations, with those that involve less perfect degrees of knowledge coming first and those that involve more perfect degrees following. Of the five categories to be outlined, three involve subjective uncertainty, one subjective risk, and one subjective certainty. This classification makes it easier to (1) understand the principles to be presented later and (2) visualize managerial problems.
When this imperfect state of knowledge exists, there are three situations of significance the inactive, learning, and forced-action situations. Two of these three situations are similar, in that the manager concerned regards his knowledge of a contemplated business (or household) action as inadequate, but willingly takes one or two alternative actions he decides to learn (acquire additional information) or, feeling that learning is not worthwhile, (inertia
'The classification presented here is not an impromptu one. The writings of Knight, Hart, Tintner, Wald, Marschak, and others were considered and the system evolved as one that would be meaningful to farmers, farm managers, and research or extension men working for and with them. The subjective nature of the classification appeared increasingly necessary if realism was to be retained.
F. H. Knight, op cit.
A. G. Hart, op cit., and Anticibations, Uncertainty and Dynamic Planning. Studies in Business Administration, Vol. XI, No. 1 Chicago: University of Chicago Press, 1940.
A. Wald, Statistical Decision Functions New York: John Wiley and Sons, Inc.. 1950" Sequential Analysis New York: John Wiley and Sons, Inc., 1947.
G. A. Tintner, "A Contcibution to the Nonstatic Theory of Production," pp. 92-99 in 0. Lange, et al. (ed.), Studies in Mathematical Economics and Econometrics Chicago: University of Chicago Press, 1941.
12 BULLETIN No. 593 an.,
and ignorance increase the cost of learning) he refuses to act and to learn. The third situation exists when outside influences force him to take action even though he feels that his information is inadequate.
Often a farm manager knows so little about a contemplated action that he is unwilling to act and, at the same time, does not attach enough importance to what he might learn to offset the cost of learning. Inertia, ignorance, and the desire for leisure partially explain costs and, hence, partially explain the existence of this situation. A manager is inactive in the sense that lie refuses to take the contemplated action and refuses to try to learn. Such managers correctly say, on the basis of their opinions, that "I don't know enough about it to do anything, and furthermore, it isn't important enough for me to worry about it." To describe this situation more formally, the manager does not have enough knowledge to be willing to take a contemplated action and he does not value prospective improvements in his knowledge enough to cover the "cost" of making such improvements.
The learning situation
Managers often find themselves in the position of not knowing enough about a contemplated action to be willing to take the action but, in contrast to the inactive situation described above, attach sufficient importance to prospective improvements in their knowledge to offset the cost of making such improvements. Farmers commonly find themselves in this situation-, thus, they are continually interested in new farm machines, new varieties of crops, production methods followed by successful farmers, and other ideas, processes, and enterprises. They attend extension meetings, county fairs, and implement shows, buy farming magazines, visit one another, and travel about the country as different ways of observing and drawing conclusions. A learning situation is one in which a person's knowledge is not complete enough for him to be willing to take a contemplated action but in which he values improvements in his knowledge more than the cost of making such improvements.
1953] DECISION-MAKING PRINCIPLES 13
Sometimes farm managers find themselves forced by circumstances to take a contemplated action even though they do not know enough about it to be willing to do so. In some such situations, if time were available (i.e., if action were not forced) more information could be acquired at a cost less than its value. One commonly hears farmers say, "I did not know what to do but I had to do something." In fact, many farmers in the learning situation move into the forced-action stage because a decision must be made and action taken on the basis of incomplete information.'
Subjective Risk Situation
In many instances, a manager does not see tile probable results of a contemplated action perfectly but nevertheless has enough
information (acquired through learning and experience) to decide whether to act or not to act; further, lie is willing to accept the consequences of the decision and action. In other words, a manager "doesn't know everything about it" but he knows enough about the possible outcomes to be willing to make the choice and bear the responsibility. That is, he is "willing to risk it." In such situations, managers often buy insurance, set up safety margins, use reserves and discounts, and other formal and informal means of bearing the risk. Decisions made in the risk situation may include decisions not to act.
Subjective Certainty Apparently Perfect Knowledge
Managers seldom have perfect knowledge concerning a contemplated action but their knowledge often becomes nearly enough perfect for them to operate as though they had perfect knowledge. In these situations, managers do not set up safety margins, discount results, or keep "aces in the hole" in case of trouble. The decision may be either to act or not to act.
Discussion of the Knowledge Situations
The five definitions presented above are personal, in that they depend upon the nature of the individual manager under con' It could be argued that, conceptually, the forced-action situation is a special case of the subjective risk situation in which the marginal cost of learning is vertical due to a special force imposing severe costs for delaying decisions.
14 BULLETIN No. 593 [Jan.,
sideration. A given manager can face all five of the above situations with respect to five different contemplated actions, and, with the passage of time, can pass through more than one with respect to a given action. One manager might decide that a given amount of information is inadequate for taking a given contemplated action; such a situation would be classed as "inactive." A second manager, possessing the same amount of information, might decide that he knows enough to be willing and able to act, in which case the situation would be classed as subjective risk-'
Examples of how Managerial Principles Are and Can Be Used in Handling Change and Imperfect Knowledge
Uncertain hog and corn prices
Sometime in the summer, hog producers begin to think about the number of (rilts to lie kept for the next year's spring pig crop. On particular farms this decision is ordinarily affected, among other things, by prospective prices for hogs, corn, protein supplements; prospective supplies of hogs, corn, and supplements; and the health of the current drove of hogs. As the feeder hogs on a particular farm approach market weights, it becomes increasingly important that a decision be reached as to how many gilts will be taken off the fattening ration and placed on a ration more favorable to the development of thrifty breeding animals.
In this period hog producers ordinarily find themselves in a learning situation; i.e., their knowledge of hog prices, of corn prices, and of their own supply of corn is not sufficient for them to decide on the size of their breeding herd, while, at the same time, they value at more than its cost the additional information they can acquire. Thus, hog producers spend time evaluating current trends in prices of hogs and corn. They also begin to make
I Some economists may object that the classification of the degrees of knowledge on a subjective basis is not practical. They argue that such a classification is hard to use as a basis for empirical research. If management is, in fact, a subjective process, then how can a researcher, confining himself to its objective aspects, fully study it? Further, is empirical research the only research of value? Further, why cannot subjective processes be objectively studied? An architect objectively studies a family's subjective wants and preferences as a basis for designing an objective plan for satisfying the subjective wants and preferences of the family.
1953] DECISION -MAKI NG PRINCIPLES 1
tentative estimates as to the size of their own corn crop and the amount of it that will be left over to feed the crop of spring pigs after feeding the desirable quantities to other classes of livestock.
If the day when the gilts must be separated from the market hogs approaches before the producer acquires enough information to be ready, willing, and able to act, he may desire to follow a strategy that will keep him from getting into a forced-action position. One way of avoiding the final decision as to size of breeding herd is to keep a fairly large number of gilts. on a tentative basis a few extra gilts can be held on a nonfattening ration for a month or two at a relatively low cost. The costs would include, among other things, (1) the possible occurrence or effect of a seasonal decline in the per-pound value of the gilts if they are eventually marketed, and (2) reduced efficiency in their gains when placed on a breeding-herd ration. Here the problem is to avoid paying more for additional flexibility (the ability to postpone decisions) than such additional flexibility is worth. (See the flexibility principles, items 2 and 3, page 33.)
If ability to postpone the decision as to size of breeding herd is acquired, the learning situation is prolonged. Consequently, more time must be devoted to learning about prospective supplies of corn, protein supplements, prospective prices of hogs and corn, and the health of the hogs crn the farm. However, the date is eventually approached beyond which breeding for the spring pig crop can no longer be put off.
If on that date 'the manager has not accumulated enough information to be ready to decide on the size of his breeding herd, he may further postpone the decision by breeding extra gilts and then keeping them until just before they get so "piggy" as to be heavily docked on markets for slaughter animals. It is logical for a manager to follow such procedures provided he values prospective improvement in his knowledge more than (1) the cost of providing the flexibility necessary to use such knowledge, plus
(2) the cost of acquiring such knowledge. If at some point in this process of accumulating information, the farmer acquires enough information to be willing to make a final choice and accept its consequences, he finds himself in the subjective risk situation described earlier.
If a manager has not acquired enough information to be ready
16 BUJLLETIN No. 593 [Jan.,
to decide on the size of his breeding herd by the time his gilts begin to get piggy, he may find himself in a forced-action situation; i.e., despite the fact that he does not know enough to be willing to act he may be forced to act.' There is, of course, the alternative of disposing of bred gilts, but the decision as to whether to produce bred gilts or slaughter animals is forced.
Some imperfect knowledge problems in beef production
The raising and specialized feeding of beef cattle have developed in varying degrees in all parts of the midwest. Beef feeding, especially, is generally characterized as a "risky proposition," "speculative" or as a gamblele" Farmers have developed various schemes for circumventing, handling, and reducing such risks and gambles.
In the central corn belt, risks in beef feeding are reduced by having a beef herd or a hog enterprise. The former provides a few feeders at a low out-of-pocket cost that will help the farmer to make up deficiencies in returns in years when feeding proves to be unprofitable. A hog enterprise is in part complementary, but it also provides the farmer with another source of income if the mar gins fall into the red in finishing cattle. As the proportion of hogs is increased relative to beef, the combined enterprises become, jointly, less risky; as the proportion of hogs becomes still higher the two enterprises may again become more risky. The amount of such protection needed by the farmer is determined in part by his financial position and his reaction to risks (see items 8 and 9, page 35 and psychological patterns, page 37). In areas where hog production is less specialized, particularly in the Great Plains where production of feed is uncertain, the hog enterprise itself becomes too risky to be used as an insurance device.
The organizational pattern adopted also depends upon a farmer's resources and other enterprises, and upon his knowledge concerning livestock prices, feed supplies, and beef (and hog) production "know-how." Thus, where beef herds fit into the farm organization, the farmer has a number of alternative lines of action. A basic cow herd may be maintained and feeder calves sold. Such an organization is rather inflexible if one's pasture becomes short
'In terms of footnote 1, page 13, the marginal cost of additional information may become almost vertical at this point.
1953] DECISION-MAKING PRINCIPLES 17
or the hay crop fails, for the alternatives are buying high-priced feed or selling part of the cow herd under disadvantageous conditions. If calf prices become unfavorable, barn space may not be available to carry the animals over even though this alternative may be otherwise advisable. When the farmer's facilities are used to capacity his organization becomes specialized and relatively inflexible. A second alternative is that of holding over calves and selling them as yearlings or even two-year-olds. This method is for the farmer who feels that he cannot foresee the future well enough to undertake a specialized, relatively unadaptable system, but who values prospective improvements in his knowledge in regard to prices and yields more than the cost of acquiring such improvements and therefore he develops a more flexible organization.
In the first alternative, the farmer obtains rapid low-cost liveweight gains with little ability to adjust to change. The second allows the farmer to adjust his plans as conditions appear to wvarrant. Under a more flexible plan, steers may be marketed when there is no economic advantage in keeping them longer, the planned grazing period can be shortened, winter feeding can be omitted if feed supplies are short, and yet the basic cow herd can be maintained. The second system is also such that expansion is relatively easy and capital outlays are not heavy in starting or expanding beef production. Thus the choice between the two systems depends partly on whether the ability to adjust offsets reduced efficiency in securing live-weight gains.'
Dual-purpose cattle are an important enterprise in many areas. They persist largely because they offer the farmer a chance to shift between milk, cream, or calf production as price relationships change. This ability to change (flexibility) has both a value and a cost, the cost arisingr from the fact that dual-purpose cattle are relatively inefficient in production of either beef or milk when considered singly. Flexibility is often valuable and should be built into a farm organization to the extent that the value of additional flexibility to the organization, in the opinion of the operator, equals or exceeds its costs. (See flexibility principles, items 2 and 3, page 33.)
' Mont Sauriderson, "What's Ahead for the Western Cattle Ranch," Thle Montana Stockgrower, 23 (No. 5), Sept. 1951.
BULLETIN No. 593 [Jan.,
A number of alternatives face a cattle feeder both before the feeding operation is started and while it is being carried on. This is a business fraught with price dangers. Those operators who feel that these price dangers are too great and who do not value prospective improvements in knowledge higher than their cost seek other alternatives. Some feeders vary their production plans, going from light to heavy cattle, from a straight roughage system to heavy grain feeding, or from many animals to few or none, depending upon expected prices and costs. The latter type of action has earned some operators the somewhat reproachful title of "in and others" and others the praiseful title of "good operators." The difference apparently lies in whether they have been financially successful when getting "in and out."
Actually, getting in and out and other types of adjusting are good business practices if such changes are based on adequate information; however, often such decisions are not carefully thought out, so that many farm managers get out when they should stay in or get in when they should stay out.
Those who undertake feeding operations may be said to be in a continual learning situation with respect to the enterprise. However, with any given group of feeder cattle, an operator often finds himself forced to take somewhat irreversible actions regardless of his state of knowledge. Thus, before buying feeders the operator can decide to buy a few or many, depending on the prospective corn supply and other factors. The age of the animals bought depends somewhat on the operator's feed supplies and experience but also on his estimate of the future strength of the fat-cattle market. Therefore, if the short-run market seems to be the safest bet, feeders favor big cattle to finish in 2 to 4 months. Long-fed, young animals not requiring a large initial investment are also relatively safe as far as long-run price declines are concerned. Calves and yearlings offer more flexibility and involve the feeder in fewer forced-action situations than older animals, allowing the operator to change strategies as long as heavy grain feeding has not progressed far. Calves are particularly flexible, if the farmer has enough pasture and roughage to make it possible to postpone the fattening period by roughing the calves through one winter and grazing through the following summer, perhaps even roughing through still another winter before finishing them
1953] DECSION-MAKING PRINCIPLES it)
out. Further, a farmer always has the alternative of remarketing these animals as feeders.
Concerning Production Methods
Variations in forage yields and requirements create important problems
Yields of pasture, hay, and grass silage are highly variable they depend on changes in weather, the season of the year, grazing and harvesting practices, and a wide variety of other factors. Similarly, the demand for hay and pasture on particular farms varies with weather, the seasons, the kind of livestock produced, and the production plans followed. Farm managers thus often face the problem of not knowing enough about forage yields and requirements to coordinate their forage and livestock production plans completely.
Some farmers in such situations feel that they do not know enough about forage and livestock production to engage in commercial production *of forage-consuming livestock at all. Among such farmers are two more or less distinct types. Farmers of the first type feel that what they could learn would not be worth the effort, hence they do not engage in commercial production of forage-consuming animals and do not try to learn about such production problems. They are in the inactive situation described on page 12. Farmers of the second type, on the other hand, feel that what they could learn about such production processes would be worth the cost and effort of learning. They are in the learning situation described on page 12. As a result, the second type of farmer engages in various learning processes with the object in mind of eventually engaging in forage production and feeding operations.
By and large, the learning techniques used fall into two categories. In some instances, farmers concerned with forage and livestock production problems reason inductively from observed experiences, experimental data, and isolated facts to generalizations concerning a universe of facts. In such cases they can use the principles and generalizations presented on pages 33 to 35. In other cases, farmers reason deductively with budgeting and eco-
20 BULLETIN No. 593 [Jan.,
nomic principles to arrive at the implications of a set of facts known or assumed to be true; that is, they can make particular use of principle 1, page 33. More often, inductive and deductive reasoning are used together in drawing conclusions.
In pasture production, perfect knowledge as to yields can never be acquired. Hence, managers may try to devise strategies to reduce the impact of variation in pasture yields on their business. A Kentucky Agricultural Experiment Station publication indicates that farmers can reduce variation in pasture yields by four main methods:' (1) choice of plant mixtures; (2) such practices as rotation grazing, seasonal applications of fertilizer, mowing and underutilization of pasture to leave residuals for consumption in short periods; (3) storage of surplus pasture forage for use in deficit periods; and (4) control of the soil water supply. Each of these methods has a cost; each produces valuable stability. Obviously, it does not pay a farmer to spend more for additional stability than such stability is worth. In a forced-action situation a farmer would want to select the alternative, among those open to him, that would involve the smallest possible loss'(see item 1, page 37) .
Imperfect knowledge and soil conservation
The current imperfect state of knowledge concerning the costs and benefits of soil-conserving systems tends to inhibit the acceptance of such systems. Technical input and yield data are missing in some instances; in others available data are not well known.
A farmer can be expected to plan a production organization that he knows or feels will give him the greatest returns from his resources consistent with the safety and leisure he desires. Thus, a corn-belt farmer may pursue a corn, corn, oats, meadow rotation with a moderate-sized livestock enterprise because he believes it best, when actually a corn, corn, oats, meadow, meadow rotation might simultaneously yield him more corn, more oats, more meadow, and in addition reduce soil erosion. A corn, oats, meadow, meadow, meadow rotation might yield less total corn, much more forage, and do a still better erosion-control job and, under existing price relationships, it might yield a greater and less variable in'LE. J. Nesius, Allocation of Formn Resources for Economic Production of Posture Forage, Ky. Agr. Expt. Sta. Bul. 568, July 1951.
1953] DECISION-MAKING PRINCIPLES 21
come.' Acquisition of such knowledge would be of value to a farmer.
A farmer can obtain such information about his specific situation by many means. He can contact his state college representatives and Soil Conservation Service personnel. Such people can often provide him with facts that will enable him to formulate plans for his farm. Contact with other farms, experimentation, and reading are also ways of learning. Here the problem is one of speeding up the rate at which new information is acquired, of assessing the value of such information, and of reducing the cost of acquiring and analyzing the information (see pages 22 and 27 for a statement of principles).
Diversification is a technique for reducing risks
Cropping systems are sometimes diversified beyond the point most advantageous from the standpoint of complementarity and supplementarity; that is, additional crops are sometimes grown to reduce variability in total income from a cropping system. Some farmers prefer a steady income to a highly variable income, even though the latter may give them a greater average income over time. (See the psychological patterns presented on page 37.)
Certain rotation systems adopted by farmers illustrate this procedure. In small-grain areas of the Great Plains, summer fallowing is an important weed-control and moisture-conservation practice. One year in four is usually adequate for weed control, and more than one in three or four for moisture means that a large proportion of the land is not in direct production. In other areas every other year summer fallow may produce as much wheat, at lower costs, than less summer fallow. But a number of Great Plains farmers continue to use systems that involve larger acreages of fallow land than profitable from a dollars and cents point of view in order to stabilize grain yields, and thereby stabilize incomes. By following such crop sequences they forego high total production in order to secure protection against dry weather.
In farm areas where a particular product has a high comparative advantage but experiences great uncertainties in price or yield compared to other products, it is common strategy to comI Earl 0. Heady and Harald R. Jensen, The Economics of Crop Rotations and Land Use, Iowa Agr. Expt. Sta. Res. Bul. 383, 1951.
22 BUILLMrN No. 593 [jail.,
bine such an enterprise with one that is relatively more certain (see insurance principle 3, page 36) The latter enterprise provides the farmer with a stable income component at a sacrifice in total income over time, while the former provides the bulk of the income and a chance to hit the jackpot.
Forage-consuming livestock on lands that have a high comparative advantage in cash-grain production in the Great Plains provide an example of this. On some farms more cattle are kept than are necessary to utilize nonarable land and the minimum amount of pasture for a rotation. This reduces the land available for wheat production. The comparative advantage of wheat is such that every arable acre taken from this use beyond that required for soil management and put into livestock uses represents foregone money income. The gain offsetting this money cost is the increase in stability.
Yields and incomes became so stable in the 1940's or the comparative advantage of grain increased so much, that many Great Plains livestock enterprises have disappeared, even to the point of undergrazing, nontillable pastures. Farmers presumably feel that this source of income stability is no longer needed or is too costly relative to the income and leisure foregone.' Like any form of insurance, it hurts a little to give up the premium ( higher foregone income from grain) but the feeling of security is valued; if the worst happens, the more stable source of income and the liquid capital reserve that the beef or dairy herd provides will tide a Great Plains family over a few years of low prices or low yields. The question is whether the value of such security to the individual concerned exceeds its cost.
Concerning New Developments and Inventions
Changes affect the value of building investments
Farm buildings represent rather definite long-term commitmenits on the part of the farmer. The farmlands of this country, particularly in the Great Plains, are dotted with horse barns which stand as monuments to past production methods. These barns
In some cases other forms of stability have been substituted, such as cash reserves, crop insurance, large scale of operations, summer fallow, and rotation changes.
1953] L)ECISION-MAKING PRINCIPLES 23
can be adapted only with difficulty to the type of farming now carried on. There is need for much forethought in making decisions in regard to new farm buildings. Because needs for buildings change, farmers are torn between the alternatives of constructing efficient (for one purpose) inflexible one-use buildings and less efficient (for one purpose) but flexible buildings (see the flexibility principles, items 2 and 3, page 33).
In this day and age of rapidly changing technology and market situations, a farm manager can protect himself from losses by building flexible structures that can be re-allocated to new uses, or low-cost semi-permanent specialized buildings that can be quickly depreciated.
In the corn belt and elsewhere, uncertainty of tenure on the part of renters and uncertainty of future relative prices on the part of owners often encourage the construction of low-cost, shortlived (portable) and, sometimes but not always, less efficient hog, and poultry facilities.
Actions of this type represent adjustments to imperfect knowledge concerning future events. An operator often incurs higher fixed costs per unit produced, foregoes the satisfactions derived from pretentious structures, and assumes certain inconveniences and perhaps inefficiencies, for the sake of greater safety (insurance) and greater ability to readjust (flexibility).
Lack of knowledge concerning the future usefulness and productivity of a long-lived capital investment often makes it good policy to discount incomes from such items at a high rate in planning, budgeting, and in income tax computations. Such discounting results in safety but also has a cost. High discounting in budgeting prevents receipt of certain risky incomes. High discounting for tax purposes may result in higher future taxes. Discounting is properly used when the value of additional discounting is equal to these costs. (See item 2, page 36.)
New inventions create investment problems
The introduction of new machines may necessitate heavy additional capital commitments, make former investments obsolete, and require other organizational changes. The combine-thresher, for instance, at first slowly and now more rapidly, is replacing threshers for small-grain harvesting all over the United States.
24 BULLETIN No. 593 [Ja n.,
Whether the individual farmer buys a combine or other new machine depends upon his resource position, the expected capital loss due to a change, the comparative costs, the comparative labor and other resource requirements, other alternatives for this investment, and whether the individual considers "the new-fangled thing important to him anyhow."
The farmer, currently caught short of capital funds, who has stretched his credit to the limit and who feels that the liquidation of other farm resources to acquire a combine would be uneconomical, is forced to decide not to take what otherwise appears to be a desirable action. If a farmer feels that such investments would be wise but is limited by lack of credit, he is caught in an external capital rationing situation where institutional lenders are not as certain as he is concerning his ability to make repayment either from his assets or his income.
In the more usual situation, a grain farmer who does not own a combine wants to know if he should buy one. What processes should he go through before taking action? What information does he need to make a decision? He should try to ascertain the labor and fuel requirements and their seasonal distribution under the new technology versus the old; he should also learn about costs and returns in the alternatives open to him.' This is a case of deducing the implications of a set of data and information. The farmer sets down (in more or less of a budget form) the facts he has available to aid in formulating a solution to his specific problem and then determines, by their logical implications, whether or not to replace threshing with combining. The situation pictured may be brought to a head by a labor shortage. If the farmer still is not sure, custom combining may be a temporary alternative to purchasing. The time to learn gained by the use of custom combines often has a cost in the form of high custom rates relative to the foregone opportunity of using one's own combine; hence, it is necessary to be sure that additional time so purchased does not cost more than it is worth. If the time so purchased is to have value, it must be used in learning. (See the flexibility principles, items 6 and 7, page 34.)
Budgeting is a technique whereby the individual may formally 'Timeliness would be reflected in reduced costs and changes in quality of product in returns.
1953] DECISION-MIAKING PRINCIPLES 25
compare alternatives. For this approach to be effective, a farmer must glean facts efficiently, ask the right questions, and observe the right data (See item 1, page 36) He can protect himself from extreme consequences of wrong decisions by making decisions that involve lower capital costs until he knows more about the type of machine he is buying. That is, lie may acquire safety by incurring greater per unit costs on short-run operations by using custom work, buying small machines, or using less efficient "old type" machines. (See item 2, page 36.) Antibiotics make learning important
Technological changes create the need to learn. What kind of evidence or knowledge should be on hand before adopting a new product or idea? The old adage is "be not the first by which the new is tried nor yet the last to lay the old aside." (See items 3 and 4, page 35.)
Antibiotics are a case in point. Compounds such as streptomycin, aureomycin, penicillin, and B12 have been reported as giving (1) phenomenal feed savings through increased daily gains and reduced death losses when added to hog and broiler rations, and (2) increased egg production and feed efficiency when used in laying mashes. There are also reports to the contrary.
Farm magazines have painted glowing pictures of the advantages of antibiotics in the feeding of nonruminants. Feed and pharmaceutical companies have advertised them widely. Many farmers know neighbors who have had seemingly good success with these compounds. Yet some people, farmers and researchers, have found evidence to the contrary. In analyzing such evidence, farm-. ers discover that the difficulty may be due to a number of things. Antibiotics are, among other things, germ killers. Therefore, when used in hog feed, antibiotics rid the hogs of certain bad (and good) micro-organisms. This, in turn, makes them thrive, thereby increasing gains and bringing about feed savings not otherwise possible. It follows that hog herds not affected with such undesirable micro-organisms do not give similar responses. The same compounds fed to ruminants (cattle, sheep) could actually destroy the organisms that synthesize proteins in their digestive systems. Researchers have found that some antibiotics and combinations of antibiotics give responses, and that some do not. The researchers do not as yet know why.
26 BULLFTIN 'No. 593 [jan.,
What should an individual farmer do in this and similar situations where technological changes not entirely accepted under farm conditions are introduced? In this case, the cost of trying antibiotics is probably small and the gains may be great. The information to be gained probably has a fairly high value and can be obtained at a low cost by experimenting with antibiotics as a method of learning about them in one's specific situation.
Introduction of new plant sprays and powders create managerial problems
Scientists have also presented us with sprays and powders which help to control weeds, insects, and rodents. These chemicals, while producing many beneficial effects, are not entirely proved and are capable of producing undesirable side effects. How can a farmer learn more about them, their advantages and disadvantages for his farm, and still protect and insure himself? There is sometimes a premium on getting into a new thing quickly, as was the case with hybrid corn. How can a farmer speed up the process by which he decides what is a good innovation to adopt? A "wait and see" attitude involves costs which must be offset by the value of what is observed or seen. On first hearing about sprays, farmers could speed up the rate at which they gain knowledge by (1) asking their county agents, (2) writing to their state experiment stations for further information, or (3) contacting dealers about them. Formal or informal records are advantageous in keeping observations and providing essential data with which to judge whether additional returns due to new sprays are greater than the additional cost of such sprays. An approximation of this can be obtained beforehand by setting down the pros and cons, the costs and returns, on the basis of the best data available. (See item 1, page 33.)
Summarizing, a farmer wishes to learn about new technological changes rapidly and efficiently. He wants to know whether they will pay on his farm. He wants to know how they affect his use of land, labor, and capital. The sooner he knows, the better. Farm radio broadcasts, newspapers, magazines, and other publications, conversations with neighbors, observation of their practices, and county agents help him in his constant quest to reduce unknowns to knowns, to reduce variability in outcomes. On his own
19331 DECISION -MAKING PRINCIPLES 27
part, lie must become a good observer, watching the steps in succeeding events, to help in formulating his decisions. The keeping of financial and other records in farm operation and specific enterprises and trials provide him with basic data for planning future operations. Budgeting is a deductive process that formalizes plans, crystalizes analysis, and thereby reduces the possibility of errors.
Therefore, although a farmer does not have perfect knowledge concerning sprays and other new developments, he can learn more about them, perhaps enough to make a positive decision in regard to a trial. New developments, as knowledge grows concerning them, may become a permanent addition to everyday practices; that is, the manager becomes subjectively certain (see page 13) with regard to such practices.
. Concerning Human Behavior and Capacities
Personalities must be handled
Changes in the people associated with a farm business are iniportant sources of both trouble and benefits. For instance' changes in the integrity and reliability of a farmer, his wife, and his children often have tremendous impacts on individual businesses. High integrity and reliability open the door of business the reverse closes it. Changes in the integrity and reliability of persons with whom business is done are also important a dishonest hired hand, unreliable credit men, "shady deal" traders, and such all have their possible impacts on a farmer's business.
What are the principles followed by managers in handling these personality changes? Basically, the principles fall into two categories: The first category contains principles for learning about changes in personalities; the second contains principles for protecting a business against such changes. (See strategy principles, pages 34-36.)
Thus, managers attempt more or less continually to appraise and evaluate the integrity and reliability of persons associated with the business. Experience helps them decide what to observe as a basis for analyzing personalities. This type of uncertainty makes it necessary for managers to engage in both inductive and deductive reasoning. Yet, despite such effortsfarmers are often unsatisfied concerning what they know about the personalities
28 BULLETIN No. 593 [Jan.,
they deal with. Hence, they look around for ways and means (strategies) for protecting their businesses against such changes.
Among such forms of protection are various typos of formal and informal insurance schemes. (See page 36.) Some managers, for instance, carry heavy liability insurance on their automobiles as protection against the possible wrecks of careless teen-age sons. Sometimes in agriculture, and much more commonly in industry, employees are bonded to insure against dishonesty..
I In agriculture, most insurance schemes for handling the risks and uncertainties arising from personalities are informal. Wages to unreliable people are reduced to provide a financial cushion against the effects of their unreliability. Lending agencies charge higher interest rates or refuse to make loans at existing rates to unreliable or unknown farmers. (See items 2 and 3, page 36.) Leasing arrangements such as written contracts, short leases, automAtic liens provide safeguards for both landlord and tenant against the capriciousness and possible dishonesty of each other (see item 2e, page 37). Another technique widely used in handling unreliability and dishonesty involves their elimination through training and development of pride in moral and productivity standards. Religious thought and school and family training are thus valuable from a business standpoint as well as from religious, ethical and moral standpoints (see item 2f, page 37).
Most protection (informal insurance) schemes have costs and the protection has a value. Such schemes are used to an optimum degree when the additional protection derived from the additional time and effort devoted to them is just worth the cost of such additional outlays. This is true also of the time and effort devoted to learning about personalities.
Change and lack of knowledge are important in personal relationships that grow up in local bargaining situations
In farming, items and services about to be put up for sale often have special location value for the buyer or the seller or both. A parcel of land, for.instance, may have a special value for the seller because it adjoins a tract of land already owned and operated. Similarly, the same parcel of land may have a special value for a prospective buyer because it is also adjacent to land he owns
1953] DECISION -MAKING PRINCIPLES 29
and operates. In this case, both buyer and seller attach more value to the parcel of land than other members of the economy would place on it and it is worth more to them. The problem of pricing the parcel of land then becomes one of personal relationships between the two individuals concerned. The bargaining techniques employed in arriving at a price are likely to include strategic operations. Strategic operations, in contrast to those in an economy determining a free price among many competitive buyers and sellers, are personal in nature. The authors know of instances in which a buyer and seller of such a piece of land have haggled and bargained for years in trying to arrive at a price mutually acceptable to them. Such haggling and bargaining often include: (1) attempts on the part of the buyer to cover up how much he really wants the land, (2) attempts on the part of the seller to build up the value of the land in the eyes of the prospective buyer, (3) attempts on the part of the seller to indicate that he is really not interested in selling the land, whereas he is actually willing to sell at a high enough price, and (4) a wide variety of other subterfuges more or less bordering on deceit. (See page 37, items 2a to 2f.)
In such cases, buyers often wait for a strategic time in which to buy the piece of land. The strategic time is likely to involve financial embarrassment on the part of the seller, the settlement of his estate, or some other more or less personal situation which makes him or his heirs willing to part with the land.
The above discussion indicates that often farm managers do not deal in impersonal competitive markets of the nature assumed in competitive economic theory. Instead, buyers and sellers often confront each other in a very personal relationship, each trying to influence and outdo the other. Lest the reader think that tiiis sort of procedure is unimportant in agriculture, let him recall that a "good bargain" in the purchase of land greatly strengthens a
farmer's credit position and his ability to command both working and investment capital for the proper operation and development of his farming operations. On the other hand, a poor bargain in buying land may wreck a farmer's credit position and reduce his income for years.
30 BULLErIN No. 593 [Jan.,
Changing governmental arrangements create managerial problems
Governmental arrangements are always more or less temporary. Thus, farm incomes which depend on governmental arrangements, like milk marketing agreements, production control, and price support programs, are never perfectly foreseen.1
An outstanding government arrangement that affects farm incomes exists in the burley-tobacco producing states in the southern fringe of the midwest Kentucky, Tennessee, Missouri, Kansas, Indiana, and Ohio. In these states, acreage control and price support programs have maintained an artificially high price for burley. This in turn has caused acreage allotments to have values ranging above $1,000 an acre in areas having the highest comparative advantage in burley production. These values, as a matter of fact, are partially included in prices paid for farm land.
Farmers in these areas have had the problem of adjusting to the possibility that the acreage control and price support programs might be eliminated, with consequent destruction of investments in acreage allotments. First, the farmers had the problem of securing some idea of what an acreage allotment for a particular farm was worth for a given year: Second, they had the problem of appraising how many years such increased incomes would exist. Then, on the basis of such information, they had to determine the present value of an acreage allotment for a particular farm. Such values do exist and are regularly priced in connection with the sale and purchase of lands.
How did farmers adjust to this situation as it developed after 1933? Early in the operation of the programs it became evident that they affected land values. Farmers found this out by following varying processes of reasoning. Some reasoned that prices of land should be increased if the programs affected burley prices. Others observed that prices of land were increasing. The first type reasoned deductively; i.e., they mentally determined an implication of a fact known or assumed to be true. The other set rea'While government arrangements are themselves subject to change, there is strong reason to believe that many such arrangments, like farm price supports. mtilk marketing agreements, and crop insurance programs have reduced the uncertainty in farming more than they have increased it.
1953] DECISION-MIAKING PRINCIPLES 31
soned inductively; i.e., they reasoned that what was happening to the price of the relatively small number of land parcels sold was happening to all similar land. (See items 1-9, pages 33-34.)
Because the future of the programs has never been perfectly foreseen, farmers have never been able to feel that the increased income from an acre of allotment would exist for a long period of time. A current study of the control programs carried out by one of the authors indicates that in 1948 the program probably maintained the price of burley about 10 cents above the level that would have existed had no programs been in effect. Assuming 10 cents to be a usable figure, a yield of 2,000 pounds per acre (a not uncommon yield in the central Bluegrass area of Kentucky), would increase in value by $200 per year.' Figured at 5% interest, a series of $200 annual incomes extending indefinitely into the future would be worth $4,000. Yet the weight of evidence is that allotments seldom bring $2,000; $1,000 per acre is probably more common in areas of high comparative advantage. This difference indicates that farmers are setting up safety factors and heavily discounting the future incomes that might be received under the programs. (See item 2, page 36.) Apparently, farm-ers think, on the basis of what they can learn about the operation of the programs, that it is safe to count on the continued existence of the progranis for another 5 to 10 years. These safety factors have a value to land purchasers because they guard him against losses. Similarly, these safety factors have a cost; i.e., if a farmer refuses to pay more than $1,000 for what may turn out to be 20 annual $200 incomes, lie forgoes a possible $3,000 (not making an allowance for interest, or if allowance is made for interest at 5% hie foregoes $1,528) The security as a safety factor, has both a cost and a value. These values and costs are personal and subjective in nature and should be equated at the margins.
Two kinds of mistakes can be made in choosing between two alternatives
When a livestock farmer is choosing between planting a cashgrain or a feed crop, he is in danger of making two distinctly dif1When the use of 8.6 acres of burley base for one year was offered on a highest bid basis near Lexington, Ky., farmers' bids ranged from $100 to $176 per acre. The successful bidder was required to plant fall cover, fturnish his own fences and barn, and pay cash in advance.
32 BULLETrIN No; 593 [Jan.,
ferent types of error. He can make the error of choosing cash grain and being wrong. Or, he can make the error of refusing to grow cash grain and being wrong.' The first .type of error has the additional consequence of eliminating a part of the feed base for his livestock enterprises whereas the second type of error does not. Thus, in analyzing such problems and in making such decisions, it is important to consider separately the two kinds of errors that can be made in choosing- between two alternatives. (See items
6 and 7, page 35.
Long-chance takers trade secure incomes for risky incomes
Farmers, agricultural economists, and businessmen experience great difficulty in anticipating future land values. Individuals, however, attach great importance to land ownership. And, because they attach such importance to land they are likely to take large risks in trying to establish ownership.
In taking such risks, elements of gambling-are involved. Under such circumstances an individual exchanges a relatively low, stable, real income for chances at two other levels of real income; i.e., hie receives a small probability of "making the grade" and' becoming an owner with all attendant rights and privileges but at the same time he runs a large chance of failing and receiving a lower level of real income.
Sensible people do not take long chances unless the combined chances of getting the resultant high or low incomes are worth enough more to them than their present certain income to cover the costs of taking the action. In a "gambling joint" such costs are referred to as a "cut for the house," whereas in business gambles, as in long-chance land purchases, such costs include among other costs brokerage fees and title fees. (See the long-chance principle, page 37.)
Summary of Principles and Generalizations
The above examples have illustrated the use farm managers make or can make of certain principles and generalizations in
' These are the Pearson-Neynan type-one and type-two errors. In the first case the farmer rejected Ho (that the feed crop was hest) and was wrong. In the second case he accepted Ho (that the feed crop was best) and was wrong. See C. IV. Churchman, Theory of Experimental Inference. The Macmillan Company. New York, 1948, pp. 8-9.
1953] DECISION-MAKING PRINCIPLES 33
handling change and acquiring knowledge. This summary outlines and presents in an orderly way the principles that are useful in similar situations. Not all of the principles outlined and presented here are drawn from the above examples. Instead, an attempt is made to be somewhat more complete than was possible in the, limited amount of space available for illustrations and examples.
First among the principles for handling change and acquiring knowledge is not to spend more, in time, foregone alternative opportunities, money, and effort, in performing additional amounts of any of the managerial functions than such additional performance is worth.
Simple and obvious as this statement appears, it is still the important economic principle. All other principles are less general and apply to fewer of the different (1) kinds of change and imperfect knowledge on one hand and (2) degrees of imperfect knowledge on the other. The value and the cost of performing the different managerial functions are generally personal and subjective in nature.
Principles and Generalizations Having To Do With Learning
1. Organized systems of thinking (such as those incorporated in budgeting procedures, systems of economic principles, the landuse approach to farm organization, and schemes of logic) decrease the cost of making observations and analyzing by:
(a) concentrating attention on the more important facts, thereby
eliminating expenditures of time and effort on useless facts,
(b) insuring that the necessary types of facts will be gathered.
2. When facts and data become available slowly with the passage of time, attention to the sequence in which the facts and data become available is desirable because:
(a) that sequence often helps explain observations, and
(b) economic information tends to lag and contain trends that
are useful for purposes of prediction.
3. When valuable facts and data become available with the passage of time, it often pays to spend money, time, and effort post-
31 BULLETIN No. 593 [Jan.,
poning decisions until more such facts and data become available. The ability to postpone decisions is referred to as "flexibility."
4. While learning and decision making generally have value, it pays to substitute habit, custom, and tradition for these procedures whenever the cost of the resultant errors and the value of the experience gained do not exceed the cost of learning and decision making. (Such costs may occur in both monetary and personal terms.)
5. It is unnecessary to learn unless a problem exists. Problems exist because situations differ from what it is believed they should be; therefore, beliefs are important in deciding what should be learned, observed, and analyzed.'
6. More should not be spent for additional information than such additional information is worth, and equal expenditures (in time, money, and effort) should return knowledge of equal value in all alternatives if the optimum amount of information is to be acquired.
7. The accuracy of estimates, choices between alternatives and decisions, eventually increases at a decreasing rate as the number of observations used increases .2
8. The per unit cost of accuracy (in time and effort) increases as the number of observations used increases.3
9. Learning is a cumulative process; hence, in appraising the value of the results of observing and analyzing, allowance must be made for the value of the "experience gained" as well as fof the immediate value of the results.
Strategy and Generalizations
Of Use in Deciding How Much Chance Ta Take
1. The seriousnes s of a given mistake in an estimate, choice, or decision depends (among other things) upon the size of the mistake; that is, how far the estimate is wrong or how great the difference between the alternatives. The accuracy of the estimate,
1 Imorance is often, hut not always, believed to be a situation worth remedying.
2The principle is as basic to the production and utilization of knowledge as the law of diminishing returns is in physical production or the law of diminishing utility is in consumption.
3 This cost relationship, of course, depends upon the preceding principle much as the nature of a marginal cost curve depends upon the law of diminishing returns.
1933] DECISION-MAKING PRINCIPLES ~35
choice, or decision, on the other hand, depends both upon the probabilities (number of chances per hundred) of making the gliven mistake (or error) and upon its size.
2. A decrease in the size of a possible mistake without an increase in the probabilities of making the mistake is an increase in accuracy, and vice versa. A decrease in the probabilities of making the mistake without an increase in the size of mistake is an increase in accuracy, and vice versa.
3. Insistence on an unusually high degree of accuracy tends to increase the amount of facts and data required to make decisions, choices, and estimates. When the amount of data and facts available depends upon the passage of time, insistence on an unusually high degree of accuracy causes delay, unemployment of assets, and reduced (on the average) but more certain incomes.
4. High tolerance for inaccuracy, on the other hand, tends to decrease the amount of facts and data required to make decisions, choices, and estimates. When the amount of data and facts available depends upon the passage of time, tolerance of inaccuracy eliminates delay, keeps assets more fully (but not necessarily more efficiently) employed, and results in less certain and (often) lower incomes.
5. The value of accuracy and the seriousness of losses resulting from mistakes are personal and depend upon a long list of items, including the psychological nature of the manager, his wants, tastes, preferences, his family obligations, his age, his debts, and his assets. The foregoing list is by no means complete.
6. In choosing, between two alternatives, two kinds of errors can be made: (1) the first alternative can be accepted as correct when in fact it is wrong, and (2) the first alternative can be rejected as wrong (that is, the second alternative is accepted) when in fact it (the first) is right. As the consequences of these two types of errors often differ, it is important to consider separately the two types of niistakes in making changes between alternatives.
7. Also decisions concerning proposed single actions involve two different errors often having very different consequences. For
-instance, the result of vaccinating hogs for cholera when it is not necessary is loss of the vaccination expenses, whereas the result of not vaccinating when it is necessary is loss of the herd.
8. As incomes -increase, people can simultaneously sustain
36 BULLETIN No. 593 [Jan.,
greater losses and spend more on attainment of security or accuracy.
9. As equity decreases or conversely as borrowing increases, the danger from errors in predicting prices and yield responses increases. This danger, of course, is one of having equity fall to or below zero.
1. It cannot be worth while carrying insurance against losses unless the personal value or importance of losses increases at. an increasing rate; that is, unless the last $100 of a $10,000 loss "hurts" worse than the loss of a $100 insurance premium. The odds of successful insurance schemes are always sufficiently against the user to pay the costs of, and perhaps profits for, operating the insurance schemes. Users of insurance exchange a larger (but less sure) higher average income for a lower (but more certain) average income. It is worth while insuring only when the lower more certain income is worth more (personally) than the higher less certain income.
2. Informal insurance schemes can be set up by refusing to take action except when prospective returns are high enough to pay the costs of bearing the risks involved. A part of the cost of operating such schemes is the foregone income. Thus, as additional income opportunities are foregone in setting up additional insurance schemes, such costs must be matched against the value of the additional insurance secured.
3. Informal insurance schemes can be set up by combining risks as protection against failure. The costs of such insurance occur as a result of participating in more activities than would be profitable in the absence of risks. Such additional costs must be matched against the value of the additional protection secured. Diversification beyond the amount that is advantageous because different crop and livestock enterprises complement and supplement each other is an example of this type of insurance scheme.
4. Pessimism, which is the same as overestimating the chances of disaster, can incorrectly make it appear advantageous to insure
1M. Friedman and L. J. Savage, "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, 56:279-304, 1948.
K. E. Building, A Reconstruction of Economics New York: John Wiley and Sons, 1951, pp. 121-6.
1953] DECISION-'MAKING PRINCIPLES 37
even when the importance of losses does not increase at an increasing rate.
The long-chance principles'
1. It cannot be worth while accepting, at unfavorable odds,
(1) a small chance of a large gain or (2) a large chance of a small loss, in exchange for a more certain income unless the personal value and importance of gains increases at an increasing rate.
2. Under long-chance principles, optimism, which is the same as over-estimating chances of success, can make it incorrectly appear advantageous to take long chances, even when the importance of gains does not increase at an increasing rate. Some other strategy principles2
1. A principle that can be followed in risky situations is to select that alternative course of action that minimizes the maximum losses which can be incurred.
2. In dealing with personalities who can in turn react to strategy, the following strategies often have value:
(a) A random, apparently nonlogical course of action often confuses the person in question.
(b) Covering up of actions often confuses the person in question.
(c) Nonrevelation of intentions prevents the person in question
from taking effective counteraction.
(d) Uncovering of the intentions of or logical patterns of action
taken by the personality being dealt with makes it easier to
(e) The use of force resources (economic, political, social, etc.),
covering up, and misleading within legal and moral limits is necessary when competing with persons who use similar
(f) Reconstruction of the systems of importances held by the
person in question often makes it possible to handle him
more advantageously. (See items (2) and (3) page 29.)
Some Psychological Patterns ConcerningThe Value of Gains and Losses
1. Persons normally attach increasing importance to additional losses up to a limit and then decreasing importance to additional
'M. Friedman and L. J. Savage, op cit. K. E. Boulding, op cit., pp. 118-21.
- J. McDonald, op. cit. J. von Nemnann and 0. Morgenstern, op. cit.
3 M. Friedman and L. J. Savage, op. cit.
38 BULLMIN No. 593 [Jan.,
losses beyond such levels; hence persons ordinarily do not insure against losses beyond some limit.
2. Persons normally attach increasing importance to additional gains up to a limit and then decreasing importance to additional gains beyond such limits; hence, persons ordinarily do not take long chances for stakes beyond some limit. '
3. The importance attached to possible gains and losses depend on many factors such as the psychological nature of the manager his family obligations, the beliefs and values of his neighbors and members of the community, his education, the amount of analyti. cal experience he has had, his asset position, his debts, his age, etc.
4. Newly rich and newly poor persons are apt to be "abnormal" with respect to the importance attached to losses and gains and, when abnormal, may run to either extreme, i.e., toward security seeking or risk taking.
5. People who are abnormal with respect to the importance of losses and gains include the extreme long-chance taker and the extreme security seeker. The extreme security eeker will pay abnormally large amounts for security (perhaps even at the expenseof his own and his family's welfare). The extreme gambler will pay abnormally large amounts for a chance of "hitting it rich" (perhaps even at the expense of his own and his family's welfare) .
The body of economic literature dealing with management and its functions has several implications for the field of farm management. The literature indicates, for instance, that the existence of change and the lack of knowledge creates the need for management. Thus, a center is needed in each business for the purpose of acquiring, analyzing, and adjusting information thereto
- that center is management, and its functions are those of observing, analyzing, deciding, taking action, and bearing responsibility.
Reflection on these concepts indicates that managers are mainly concerned with problems falling in five subject-matter areas: changes and lack of knowledge concerning (1) prices, (2) production methods and responses, (3) inventions, (4) human behavior, and (5) economic, political, and social institutions.
1953] DECISION-MAKING PRINCIPLES 3
Further thought indicates that managers find themselves in one of five different knowledge situations with respect to a given problem. Examination of these five situations provides a useful basis for learning managerial principles. The five situations are:
(1) the inactive situation, in which available information is inadequate for a decision concerning a contemplated action and in which the cost of acquiring more information exceeds its value;
(2) the learning situation, in which available information is inadequate for decision and in which the value of acquiring knowledge exceeds its cost; (3) the forced-action situation, in which available information is inadequate but in which action is forced by outside circumstances;' (4) the subjective risk situation, in which available knowledge, though imperfect, is adequate for either positive or negative action and in which the cost of additional knowledge equals its value; and (5) the subjective certainty situation, in which knowledge is complete enough for managers to act as though they had perfect knowledge. The first three of these situations all involve inadequate knowledge; they can be grouped together under the label of subjective uncertainty.
Several principles in economic and statistical literature serve to increase the efficiency with which the five managerial functions, outlined in the first paragraph above, are performed. These principles have to do with learning (observation, analysis, and, in part, decision making) and strategies with certain psychological patterns serving to explain partially the risks which managers will accept and the degrees of security they try to attain. See pages 32 to 37 for a summary of the principles and generalizations concerning learning, strategies, and psychological patterns.
Examination, in the manuscript, of a large number of managerial situations faced by farmers serves to illustrate the wide applicability of the above summarized principles and generalizations to the management of farms.
See note 1 p. 13 for a discussion of the forces.
40 BULLETIN No. 593 [Jan.,
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