Income Variation and Selection of Enterprises

Abstract

quantities of time and effort in the analysis of farm enterprise combinations that maximize expected or average profits. Indeed, since the advent of electronic computers at nominal cost, linear programming has provided a vast amount of useful information on the relationship between income and enterprise mix, product and input prices, and resource availabilities. On the other hand, the variance of expected income, perhaps equally important, has been seriously neglected in farm management research. Although income variability has long been recognized as an important component of farmers' decision-making process, the first attempt I have found in the farm management literature at more than a cursory analysis of the income variance problem was made by Heady in 1952 [4]. Heady laid out the logical relationship between total income variance and diversification in resource allocation and gave some empirical examples of how variance changes when one product is substituted for a second. Since that time, a few studies [1, 3, 5, 8] have extended Heady's analysis and derived empirical estimates of income variance for various farm enterprises. Despite these valuable contributions (as well as others not cited), there is little evidence of a general interest among production economists in applying these concepts to farm planning analysis. The purpose of this paper is to revive research interest in income variability by showing some implications of the effects of enterprise selection on total income variance and to suggest a method for using income variance in farm planning. The suggested method, utilizing quadratic programming, is adapted from techniques used to select investment portfolios so as to minimize the variance of expected returns [2, 6, 7]. The Total Variance Function