The risks that farmers take: An experiment on externalities with individual thresholds

Abstract

Inspired by fertilizer use, we investigate behavior in settings where externalities arise from individual activities crossing an uncertain individual threshold. We show within an analytic model that only threshold uncertainty causes individual and social interests to diverge with individuals accepting a larger probability of crossing the threshold than is socially optimal. We then theoretically investigate the impact of information on thresholds as well as taxing the caused externalities or fertilizer use. We test our predictions within an experiment with farmers as well as with students. We find that, even without any regulation in place, farmers invest significantly less than their payoff-maximizing level, but on average close to the social optimum. The probability of exceeding the individual threshold and the resulting damages significantly decrease when subjects are provided free informative signals or have to pay for caused damages. In contrast, taxing inputs (fertilizer use) does not decrease the risk of causing external effects.