Farms, Families, and Markets: New Evidence on Completeness of Markets in Agricultural Settings

TLDR

The farm household model, which assumes complete markets and price‑taking behavior, has been widely used to analyze small‑scale agricultural households, but its key assumption of market completeness remains untested and is a major challenge for developing empirically tractable models. This study tests whether farm labor demand is independent of the farm household’s demographic composition. The authors use multiple waves of longitudinal survey data from Central Java, Indonesia, to examine this relationship. The analysis rejects the prediction that labor demand is unrelated to household demographics, and the result cannot be attributed to unobserved farm‑level heterogeneity or local shocks, leading the authors to conclude that the recursive farm household model is inconsistent with the data.

Abstract

The farm household model has played a central role in improving the understanding of small-scale agricultural households and non-farm enterprises. Under the assumptions that all current and future markets exist and that farmers treat all prices as given, the model simplifies households' simultaneous production and consumption decisions into a recursive form in which production can be treated as independent of preferences of household members. These assumptions, which are the foundation of a large literature in labor and development, have been tested and not rejected in several important studies including Benjamin (1992). Using multiple waves of longitudinal survey data from Central Java, Indonesia, this paper tests a key prediction of the recursive model: demand for farm labor is unrelated to the demographic composition of the farm household. The prediction is unambiguously rejected. The rejection cannot be explained by contamination due to unobserved heterogeneity that is fixed at the farm level, local area shocks or farm-specific shocks that affect changes in household composition and farm labor demand. We conclude that the recursive form of the farm household model is not consistent with the data. Developing empirically tractable models of farm households when markets are incomplete remains an important challenge.