CUMULATIVE PROSPECT THEORY: A STUDY OF THE FARMERS' DECISION BEHAVIOR IN THE ALENTEJO DRYLAND REGION OF PORTUGAL

Abstract

The mid-term review of the Common Agricultural Policy will change the way the European Union supports its farm sector. The new Common Agricultural Policy will be geared towards consumers, and taxpayers, while giving farmers the freedom to produce what the market wants. In the future, the majority of the subsidies will be paid independentlty from the volume of production. To avoid abandonment of production, Member States may choose to maintain a limited link between subsidy and production under well conditions and within clear limits. These new single farm payment will be linked to the respect of environmental, food safety and animal welfare standards. Severing the link between subsidies and production will make farmers more competitive and market oriented, while providing the necessary income stability. As the subsidy becomes a common component of all the alternatives of decision, the farmer will segregate that common component of the problem in the edition phase, starting to make decisions with base in negative results, what can determine the abandonment of the farming activity. This research work intends to know, to characterize and to identify the farmers' behavior in the Alentejo dryland region of Portugal, when they face to the emerging reality of the new Common Agricultural Policy. The Cumulative Prospect Theory allows to model the farmers' behavior, because besides defining that the results are appraised in agreement with variations in relation to the initial wealth, this theory treats in a differentiated way gains and losses. The value functions and the weighting probabilities are elicited by the Trade-off and Certainty Equivalent methods for a group of farmers in the Alentejo dryland region. These functions will constitute the objective function of a discrete sequential stochastic programming model, whose restrictions describe the crop and livestock farms in their productive, financial, commercial and taxes components. Model results show that the introduction of the total decoupling payments leads to the abandonment of the crop production in the Alentejo dryland region and an increase of the livestock production in the natural pastures. The crop farms stop producing, except the farms that have good soils continue to produce, although these farms do not produce durum wheat and they start to produce barley and oats. With respect to the beef cattle farms, these farms maintain the number of cattle heads, they increase the pasture and forage areas and they substitute durum wheat for oats and barley. The sheep farms reduce the number of cattle heads drastically and they substitute durum wheat for barley and oats.