In two-tier price systems, yield uncertainty creates incentives to overproduce quantity-restricted outputs even when prices for surplus output are very low. These incentives arise from precautionary motives against expected losses from quota shortfalls. Using an approach augmented for multiple input applications, the likelihood of excess production and the relative importance of price changes in different markets are estimated for Icelandic dairy farms. The results indicate that the average farm plans to exceed its quota, and price changes in the surplus milk market are approximately three times more effective in generating supply response than price changes in the quota milk market.

Although apparently preferred by farmers to direct hedging as a forward pricing mechanism, forward contracting has received little attention in the literature dealing with optimal forward pricing levels. An often-cited reason for producer preference for forward contracting is the absence of basis risks under that forward pricing alternative. This paper presents models of optimal forward contracting and hedging under price and yield uncertainty within a mean-variance framework. The results indicate that basis certainty does not explain preferences for forward contracting.