RISK AND UNCERTAINTY

Farming takes place in an environment characterized by risk and uncertainty (eg.. much rain,
drought, diseases, lack markets, low prices, etc).
Uncertainty is when possible outcomes and their respective probabilities of occurrence are
not known.
Uncertainty cannot be dealt with as easily. If the outcomes and the probabilities associated
with each outcome are not known, the insurer would not be able to write a policy with a
premium sufficient to cover the risk.
Risk is when both the outcomes and the probabilities of occurrence are known. It is easy to
deal with risk. -For instance, the insurer can discover the outcomes and the probabilities of
their occurrence and write a policy with a premium sufficient to cover the risk and net a profit
to the insurer.

Types of Risks and Uncertainties:

They are classified into five categories:
1. The economic uncertainties are markedly reduced in many economies where input and
product prices are announced before sowing a crop. Economic uncertainties of this nature are
usually caused by national and international policies which are beyond the approach of an
individual farmer.
2. Biological uncertainty is quite common and important in agriculture. Rains or drought,
floods, hailstorms, frost, etc., may all affect the yields in agriculture directly or indirectly by
increasing the incidence of crop or animal diseases.
3. Technological uncertainties: Continuous advancement of knowledge through research
activities has made more efficient methods increasingly available for agriculture.
Simultaneously, new inventions and innovations may result in an increased efficiency of the
existing methods. Thus, improvement of knowledge which is continuous phenomenon may
render some techniques less efficient and finally obsolete. Such a change is known as
technological progress in agriculture can be found in different methods of cultivation and in
fertilizer, irrigation and chemical applications giving different yield responses. Technological
improvement necessarily implies that the same level of input can now produce larger
quantities of the produce.
4. Institutional uncertainties: Institutions like government, banks, etc., may also cause
uncertainties for an individual farmer. Crop cess, credit squeeze, price supports, subsidies,
etc. may be enforced or withdrawn without taking an individual farmer into confidence. This
type of uncertainty may also result in non-availability of resources in appropriate quantities
and at the appropriate time and place (eg subsidized fertilizer in Kenya, which is sometimes
not available or accessible to farmers during harvest and this delays planting).
5. Personal uncertainties
The farm plan may not be executed because of some mishap in the farmer’s household or in
his permanent labor force.eg (farmer may fall sick).

Strategies employed by farmers to deal with/ mitigate risks

1. Insure against Risk: Insurance policy reduces income variability arising from risk. For
instance, crop insurance (e.g Kilimo salama…) plans have the effect of making the farmer's
income from one year to the next more even. When a crop fails, an insured farmer will be
compensated and will be able to produce for the next season.
2. Contracts: Contract allows sell a specified commodity at a specified price for delivery at
some future point in time. They help reduce or eliminate price uncertainty by determining
prices to be paid after harvest, or at the point when the commodity is ready for market. The
futures market is but one contractual arrangement for eliminating price uncertainty.
Contractual arrangements are commonly used for commodities such as horticultural crops
(eg.Murang’a Ovacado contract arrangement system)
3. Selection of enterprises with low variability: There are certain enterprises where the
yield and price variability are much lower than for others. For example, wheat has relatively
much less variability in its yields and prices in irrigated regions than potato. Thus, the
inclusion of enterprises with low variability in the farm plans provides a good way to
safeguard against risk and uncertainty.
4. Flexibility: This refers to the convenience with which the organization of production on a
farm can be changed. Some organizations are obviously more flexible than others and
flexibility in an organization through change in production helps obtaining advantages and
improvements in the economic and technological environment of a farmer. As an uncertainty
safeguard, flexibility may be built into farm plan for stabilization of incomes from year to
year and to maximize the expected stream of total income over a longer period of time. It
differs from diversification in the sense that it aims at preventing the sacrifice of large gains
as compared to the prevention of large losses through diversification. Due to technological
and economic changes certain enterprises may suddenly gain or lose importance over time.
Thus, quick changes may be required which can only be brought about at a low cost if the
plans are not rigid but flexible. Flexibility can be of the following types:
 Time flexibility: Time flexibility may be introduced either through proper selection of
products or production methods or partly by both. Orchard plantation is a relatively more
rigid enterprise than annual crops like wheat, maize, paddy, etc. A short lived farm structure
or equipment is more flexible than one which durable.
 Cost flexibility: whenever time flexibility is of limited use, cost flexibility becomes
important. Cost flexibility refers to variations in output within the structure of a plant with a
longer life. Extension or contraction of output, whenever desired by favourable prices or
yields, can be brought about at lower costs for a given plant. Though a farmer may find that
owning a potato digger on his farm would result in lower costs than those which have to be
paid for custom hiring a similar one, yet he may keep on hiring machine in order to have
more cost flexibility on his farm.
 Product Flexibility: product flexibility, like any type of flexibility, aims at changes in
production in response to price signals. In this category we consider the form of physical
resources, e.g. machines, farm structure, etc., which can be switched readily from one product
to another. If a farmer is to adjust to changing relative product and input prices, it must be
possible to adapt buildings and equipment lasting more than one production season to
alternative uses as input and output price ratios change.
5. Diversification: Diversification is a very important, useful and popular method to
safeguard against risk and uncertainty in agriculture. It involves mixing two or more
enterprises. Diversification enables profits from one type of enterprise offset losses in another
enterprise. The strategy may be more effective for dealing with price uncertainty. The ideal
strategy would involve locating commodities whose prices always move in opposite
directions.
6. Government Programs: This are programs that provide price and income support for
farmers. The program has been directed toward the reduction of price uncertainty.
Government price support programs places floors under which commodity prices are
supported. Such programs increase incomes and support the welfare of every farmer who
participates, large and small. Participation in a program reduces income variability and raise
net farm incomes as opposed to nonparticipation. Thus participation in the program requires
farmer to make decision by; calculating net revenue when the farmer participates.
This usually means a restricted output (y) at a high price. Calculating net revenue when the
farmer doesn’t participates. This assumes more output but a lower price. However, the
decision by the farmer to participate or not participate will be based both on the extent to
which participation in the program will reduce income variability as well as increase net
income. When government support prices exceed levels at which supply and demand are in
equilibrium, surpluses of the price-supported commodities occur. Most commodities cannot
be stored indefinitely, and storage costs can quickly become rather high. In the past, the
government has used the school lunch program to dispose of surplus, government owned
commodities. Recently the government has distributed surplus dairy products occurring as a
result of the price support program to low income and elderly residents.
7. Liquidity and asset management: It is a form of flexibility but has been put in a distinct
class because it represents a different method of management used in case of unpredictable
changes on a farm. Liquidity refers to the case with which the assets on a farm can be
converted into cash can also change its form in a relatively short time. If the assets are held in
a form which can be easily converted into cash, it provides a safeguard to the farmer by
enabling him to make necessary adjustments in response to risk and uncertainties of various
types. Eg (in times of drought in Turkana, farmers can decide to sell their livestock and
replace them back when drought is over)