Suppose farmer borrows debt

Reference no: EM131350761

The Federal Crop Insurance Corporation (FCIC) was established in 1939 to protect farmers against crop losses caused by the vagaries of weather. That is, in case of default by a farmer due to bad weather, FCIC pays back any debt borrowed from a bank on behalf of the defaulted farmer. Yet, the FCIC has relatively few inspectors to inspect individual claims. A farmer in Arizona has a choice between planting water-hungry crop and hardy crop. Both crops cost $100. The gross returns on these plants depend on the annual rainfall. If there is enough rain (the annual rainfall exceeds 12 inch; 50% probability), water-hungry crop's gross return is $200. If there is a drought (the annual rainfall is less than 12 inch; 50% probability), water-hungry crop's gross return is $0. For hardy crop, the gross return is $150 if the annual rainfall exceeds 12 inch, and is $100 if the annual rainfall is less than 12 inch.

Suppose a farmer borrows debt (with limited liability, i.e., pay back the borrowed amount, or everything he has if the cash flow is smaller than the borrowed amount) from a bank to finance the cost of planting crops. In case of farmer's default, the bank gets paid by FCIC. Which plant will the farmer choose? _______

Reference no: EM131350761

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