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A dairy cooperative certifies its farmers depending upon the quality of the milk delivered. There are 2 quality


a)    quality A- highest quality and earns an average premium to the dairy farmer of $5,000

b)    quality B- average quality and results in an average annual return of $1,500

To improve the dairy herd health status and, consequently the possibility of obtaining a higher certification level, the farmer can join a herd health management program. There are three alternatives available to dairy farmer:

1.     An intensive advisory program in which an expert will visit the farm on a monthly basis to discuss and support the herd health decisions of the farmer. The costs of this program are $2,200 annually.

2.     A general support program in which the famer can call for an expert visit twice a year. During those visits, the health status of the farm will be discussed and the farmer will receive accurate advice on how to improve the current health state of the herd. The cost is $750 per year.

The probabilities of obtaining a given certification level A are 0.65 with the intensive program and 0.20 with the general support program.


a.       Calculate the net returns to quality A and quality B milk for each of the two support programs.

b.     Which support program would you recommend to the dairy farmer using the expected value approach? Explain.

c.    At what probability of obtaining an A quality from the intensive program would the dairy farmer be indifferent using the expected value approach between the two programs assuming all else stays the same?

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