Three Essays on the Economics of Price Volatility

Abstract

This dissertation is about how commodity price volatility affects the decision making and welfare of economic agents. The three essays in this dissertation focus on food prices, the volatility of which has been an important topic of policy discussions in the wake of the global food crises of 2008 and 2010-11. In the first essay, I examine whether food price volatility causes rural-to-urban migration. Using longitudinal household survey data from rural Ethiopia, I find strong and robust evidence that the greater a household's willingness to pay to stabilize food prices, the more likely that household is to see one of its members migrate, a relationship that is more pronounced in villages that lack alternative coping strategies to mitigate the negative welfare effects of price volatility. Thus, my results provide evidence that migration is a strategy that smallholder farmers rely on to cope with food price volatility in the absence of well-functioning credit and insurance markets. The second and third essays are experimental studies motivated by a need for a clean identification of producer decision making under price volatility. In the second essay, my co-authors and I test Sandmo’s (1971) canonical theory of producer behavior under output price uncertainty using a novel experimental protocol. We find that, in stark contradiction with Sandmo's theoretical prediction, which stems from expected utility theory, the presence of price uncertainty causes subjects to produce more than they do under price certainty, but we also find that increases in the degree of price uncertainty cause them to decrease their production. Perhaps more importantly, we also find that subjects exhibit behavior consistent with prospect theory. In the third essay, we generate unique experimental data to examine how individuals make production decisions under price ambiguity, in which probability distributions of prices are unknown to experimental subjects. We find that, when producers have to make production decisions lacking such information, context matters a great deal, and individuals rely on past realization of prices as well as heuristics to facilitate decision making.