KYU/F/AA/02

KIRINYAGA UNIVERSITY

SCHOOL OF BUSINESS AND ECONOMICS

PRODUCTION ECONOMICS INTRODUCTORY NOTES

Introduction
 We live in a complex and ever-changing world where industrialization and mechanization
has brought tremendous changes in production methods used in agriculture and other production
areas
 Such changes includes;
o Changing input and output prices
o Changing demand and supply of goods and services
o Weather conditions
o Technology
 A firm manager must therefore be able to understand and react to these ever changing forces
some of which are beyond his control by seeking to adopt technically efficient production
methods. Must also be willing to learn new production techniques and use them.
 Also he must poses a basic understanding of economic principles as used in agriculture, since
economics is generally concerned with production, distribution, exchange and consumption of
goods and services. This will thus help the firm manager in dealing with the major economic
issues which includes; inflation, taxes, unemployment, energy shortages, etc
 Amidst these issues, a firm manager must know how to allocate the scarce resources in the
firm to meet the goals of the firm and at the same time react to these economic forces
Definition of production economics
 It’s the application of micro-economic principles in agriculture. It’s a field that provides a
framework for decision-making on the firm based on the theory a firm through clarifying
concepts of;
o Output response to inputs
o Cost of production
o Optimal use of resources to maximize profits and minimize cost
 By combining the study of technology of production on the farm with the analysis of how
profits seeking manager will respond to changes in such variable as input and output prices,
wage rates, interest rates, production economics is able to;
a) Analyze the effects of forces outside firm
b) Determine the impact of the changing world prices and government policies on
input use and production in the agricultural sector using the logic of production economics
c) Provide a clear perception of the problems of technical production on the farm
d) Providing a unique role in farm management
Basic Production Economics Questions
1) What is the efficient production?
2) How is the most profitable amount of input determined?
3) How will the firm production respond to the changes input and output prices?
4) What enterprise combinations will maximize firm’s profits?
5) What should the firm do when it’s uncertain about its yield response?
6) How will the rapidly technical change affect firm’s output and profits?
Goals of the Production Economics
b) Assist the firm managers in determining the best use of scared resources given the changing
needs, values and goals of the society
c) Assist the policy makers in determining the consequences of alternative public policies on
output, profits and resource use in the firms
d) Evaluate the use of the theory of the firm for improving firm management and understanding
the behavior of the firm as a profit maximizing entity
e) Evaluate the effaces of technological and institutional changes on the firm’s production and
resource use
f) Determine individual firm’s adjustments in output supply and resource use to changes in
economic variables in the economy
Economic Setting; production economics analyzes;
a) Characteristics of the markets in which the firms purchases their inputs
b) The technical and economic characteristics of the production processes within the firms i.e.
nature of costs, profits etc
c) The type of the market in which the firms sells their products
d) The recent changing trends in these firms
In production economics, we study among other things, the following:
· Organization of fims.
· Availability of inputs and their prices.
· Marketing system for the various products.
· Organization of both production marketing cooperatives.
· Demands for and supply of products and those of allied industries.

· Finances of business, role of banks, and other financial institutions in firm development.
· Private firms to identify their problems as well as the problems of government owned firms.

PRODUCTION
Definition of Production
Production is the process by which inputs are transformed into output in output producing units.
The output producing units include farms and factories.
Production therefore means changing either the form of something or its situation in space or
time, or the provision of a service of some kind. Agricultural production involves many
controllable and uncontrollable inputs. The controllable inputs include land, labour, capital,
irrigated water and management and their various disaggregated forms to give as more specific
set of factors. The controllable inputs include rainfall, other weather variables and many
variables such as animal and plant nutrition or photosynthesis which are not completely
understood. Because of the uncontrollable inputs in agricultural production, last years production
response may be estimate of this year’s production response.

Economic Resources
Land: Land is the most important resource in agricultural production. Its supply is relatively
fixed except it can be expanded slightly by drainage of swamps, reclamation from sea bodies and
water, and chemical or biological improvement of non-cultivable lands. Land (farm size) is
measured in hectares but the local farmers sometimes, refer to the size of their farms in number
of heaps.
Labour: Labour is the effort of human being that is used in making things happen in the
production process. It is the second most important resource next to land in agricultural
production. Labour availability is a function of the economically active proportion of the
population released for agricultural activities. Farm labour on peasant farms could be from both
family or hired sources depending on the size of the farm and type of operation to be performed,
but in large commercial farms, farm labour is purely hired and categorized as casual, unskilled,
semiskilled and skilled labour. The quality of labour in use is a function of the level of education
and training in relevant agricultural production, that is, the higher the level of training in the
cultivation and management of any crop the higher the productivity and efficiency.
Labour is measured in terms of the adult male equivalents, where one man day is the work done
by one adult male in eight hours, and one woman is equivalence of 2/3 of a man-day while a
juvenile is 1/2 of a man-day.
Capital: Capital resources come into farm production in three forms, namely,

· Farm machinery, such as, tractors and various farm tools

· Biological capital such as fertilizers, pesticides, herbicides, improved seeds and breeding stock
· Feed for Livestock.
Also, capital can be categorized on the basis of their cost structure, that is,
· Depreciation cost on building which are for farm improvement.
· Maintenance and running costs on machinery and equipment, livestock & feed expenses, feed
and fertilizer purchases.
· Depreciation cost on machinery.
Management: Management or entrepreneur or co-ordination is the most important factor of
production. In this input resides the decision making power in farm business. It is concerned with
efficient mixing of resources in the production process. An efficient resources planning and
utilization ensures attainment of the objective of the production function. Management is
therefore concerned with planning, implementation and control of the farm business.

3.1 Definition of Production Function

Production function is a physical or technical relationship between inputs and output in

any given production processes. It describes the rate at which inputs are transformed into
outputs. It defines the production possibilities open to the farmers. In an implicit form, the
production
function is defined as:

Y = f(x).
It states that output Y is a function of input X. Where Y = output of product, X = input used, f()
= functional form.
3.2 Types of Production Function

Production functions are classified into two based on time period. They are short run and long
run production functions.
(a) Short run production function:

In the short run production function, at least one of the inputs used can be varied with the
others fixed.
The implicit functional form is defined as:
Y = f(X , X / X , X … X ).
Or
Y = f(X , X ).
It implies that output (Y) is a function of variable inputs X and X given fixed values of inputs
X to X
(b) Long run production function:

In the long run production function, all the inputs can be varied.It is implicitly expressed as;
Y= f(X , X , X … X ).

3.3 Production Function

There are two forms of agricultural production functions: biological and farm functions.

(a) Biological functions: They are derived from experiments in

crops and livestock. The experiments may be conducted in plants,
group of animals, or using area of land as basis for
experimentation. Biological functions guide farmers in their
decisions, such as, optimal plant size, quantity of fertilizers to use
per hectare. The data used in biological functions are of
importance for purposes of policy and as an instrument for
planning economic development.

(b) Farm functions: They are used on farm survey of existing farms.
Data are collected from secondary and primary sources. Because
we do not keep good records, the better option is to draw up

questionnaires on information on average input and output

quantities, inputs and output prices, all within a given season or
time period. From this information, we fix the production
function and estimate using appropriate procedures and methods
of analysis.

3.4 Uses of Production Function

• They serve diagnostics purposes to diagnose input and output

relationship within sampled farms.
• They tell us the level of optimum use of inputs.
• Determination of the scale of production.
• They are useful in determination of enterprise combination.
• They guide farmers in decision making.

3.5 Algebraic Forms of the Production Function

The algebraic forms of the production function are the explicit

representations of the production function. The type of algebraic forms
used depends on three considerations namely;

(i) The functional form used must adequately represent the

production process it is meant to represent, that is, the estimated
function fits the data on which it is based. How well it fits our
apriori expectation about the physical and economic logic of the
production process under study.

(ii) The algebraic form should be easily estimated by econometric

and statistical procedures.

(iii) It should be easily manipulated in terms of economic analysis..

3.6 Types of Functional Forms

The common algebraic forms of production function are the linear,

quadratic, semi log, exponential, power or Cobb Douglas and
transcendental functions.

(a) Linear function

For the one variable production function the linear function is expressed
thus:

Y = a + bX.
Where Y = output, X = variable input, a = constant term, b = slope of
the line or coefficient of production parameter. The linear function is very simple, easy to work
with and mainly taught

for academic exercise since most agricultural production functions are

not adequately represented in the linear functional form.

(b) Quadratic function

The function is defined for a single variable case as;

Y=a+bX +bX
Where Y, X , a, b and b are as previously defined.
For two variable inputs, the function is;
Y = a + b X + b X +b X + b X +b X X
The quadratic function becomes cumbersome and messy to use when
there are more than three variable inputs.

(c) Semi log function

The semi log function for a single variable input is defined thus:
Y = a + b logX
For two variable inputs case;
Y = a + b logX = b logX .

(d) Exponential function

For a single variable input it is defined as;

Y = aeb1x1.
When linearised in the log form it becomes;
Log Y = log a + b X
For two variable inputs case:
Y = aeb1X1 + b2X2.
And when linearised in the log form it becomes;
Log Y = log a + b X + b X .

(e) Power function (Cobb Douglas)

The power function for a single variable input is defined as:

Y = aX .
For two variable inputs case, it is;
Y=aX X .

When the input and output quantities are transformed into logarithms,
the resultant function is linear in the log and the function becomes a
double log function.

Log Y = log a + b logX + b logX .

3.6.1 Properties of the Power Function

• The power function is multiplicative: Y = aX X

• None of the X and the estimated coefficients can be Zero since this
implies zero output.
• It does not have a maximum, it increases indefinitely.
• When linearised in the log, the function is easy to fit.
• The coefficients of the double log function are direct elasticities of
production for the variable inputs.