Principles of Agricultural and Resource Economics

AE - 401

CHAPTER 2
Physical Production Relationships
• Concepts and Definitions
• The production function
• Types of production responses
• The typical production function
• Stages of Production function
 Concepts and Definitions
 The basic objective of farmer or any business operator is to maximize
Profit.

 Profit equals the value of production sold less the cost of producing
that output.

Profit = Revenue – Cost

 Theory of the Firm: It examines the producer’s decision process at the
firm or farm level.

 Following words will be used interchangeably

Resource, Input and Factor

Production, output, Product

 Concepts and Definitions
Fixed Factors of Production are factors that have to be maintained
in the short run even if the production is zero.

Examples: Land, building, factory equipment

Variable Factors of Production are factors that vary as output level

change; that is as the use of variable factors changes output level
also changes.

Examples: Seed, fertilizers, labor

The designation of input as variable or fixed

depends on the time horizon of the firm
 Concepts and Definitions
Immediate short run is a time span so short that no resource
changes can be made.

Example: At harvesting time your grain to be harvested

Intermediate short run is a time span such that some factors are
variable and some factors are fixed.

Example: during single growing season a wheat farmer can vary

the amount of fertilizer but not the acreage.

Long Run is a time span such that no inputs are fixed.

Example: Any farmer can buy a new piece of land, livestock farm
can increase the livestock head
 The production function
Production function is defined as “the technical relationship
between inputs and output indicating the maximum amount of
output that can be produced using alternative amounts of variable
inputs in combination with one or more fixed input under a given
state of technology”.

Y = f (Xi)
Y = f (X1, X2,X3………Xn)
Y = f (X1/X2,X3………Xn)
Y = 20 + 0.4 X
 Production schedule

Production Schedule: which is Amount of X Amount of Y

essentially a tabular summary of used produced
(Fertilizer) (Wheat
the input output relationship. bushels)

Y = 20+0.4X
0 20
Y=a+bX 10 24
a= intercept = 20 20 28

b= Slope coefficient = 0.4 30 32

40 36
Find value of Y =?
50 40
when X = 15 X= 35
45

40

35

30

25

20

15

10

0
0 10 20 30 40 50 60

A linear production function

Types of Production Responses
• Constant returns
• Increasing returns
• Decreasing returns
• Negative returns
 Constant Returns
In this type of response each X Y Added output for
additional unit of input is as each added unit
productive as the previous unit. of input

0 0 2
12

10
1 2 2

8 2 4 2
6 3 6 2
y

4
4 8 2
2
5 10 2
0
0 1 2 3 4 5 6
X
 Increasing Returns

Increasing returns occur when X Y Added output for

each additional unit of input each added unit
added to the production process of input

yields more additional product 0 0

than the previous unit of input.
1 1 1
16

14 2 3 2
12

10 3 6 3
8
y

6
4 10 4
4
5 15 5
2

0
0 1 2 3 4 5
X
 Decreasing Returns
When each additional unit of
X Y Added output for
input increases the production
each added unit
level, but with a smaller change of input
than the previous input. 0 0 -
16

14 1 5 5
12

10 2 9 4
8
3 12 3
Y

4 4 14 2
2

0
5 15 1
0 1 2 3 4 5 6
X

Law of diminishing returns: as additional units of input are

combined with a fixed amount of other inputs, a point is always
reached where the additional product received from the last unit
of added input will decline
 Negative Returns
Each additional unit of input
X Y Added output for
added to the production process each added unit
decreases the production level. of input

0
18
16
1
14
12
2
10
3 17
Y

8
6
4
4 15 -2
2
0
5 12 -3
0 1 2 3 4 5 6 7 8
X 6 8 -4
7 3 -5
 Negative
returns to
scale

The production function

represents the physical
correlation between input
and resultant output.

Typical production function

The typical Production Function
 Product Curves


X TPP APP MPP

0 0 = TPP/X

1 2 2 2

2 5 2.50 3

3 9 3.00 4

4 11 2.75 2

5 12 2.40 1

6 11 1.83 -1
X TPP APP MPP

0 0 = TPP/X

1 2 2 2

2 5 2.50 3

3 9 3.00 4

4 11 2.75 2

5 12 2.40 1

6 11 1.83 -1
TPP/Y
TPP

Stage I Stage II Stage III

Irrational Rational Irrational

MPP
MPP/APP

APP
TPP APP & MPP Curves
C
TPP B • With labor time continuously
divisible, we can smooth TPP, MPPL
and APPL curves

A • The TPP curve increases at an

A = inflection point increasing rate up to point A;
past this point, the TPP curve
rises at a decreasing rate up to
point C (and declines thereafter)
APP
A • The MPP rises up to point A,
MPP
becomes zero at C, and is
B negative thereafter
• The APP raises up to point B
and declines thereafter (but
remains positive as long TPP is
C positive)
LA LB
Law of Diminishing Returns
C •This law states that as
TPP B
Total additional units of an input are
product used in a production process,
while holding all other inputs
A constant, the resulting
increments to output (or total
product) begin to diminish
beyond some point (after A, in
Labor the bottom graph)
APP
MPP A • As the firm uses more and more
units of the variable input with the
B same amount of the fixed input,
each additional unit of the variable
input has less and less of the fixed
input to work and, after this point,
the marginal product of the variable
C Labor input declines
LA LB
Stages of Production
C
TPP B Stage I L
Total
product
Is the range of production for
which increases in the use of a
variable input cause increases in
A
its average product
Stage II

Is the range for which increases in

X the use of a variable input causes
APP decreases in its average product,
Stage I Stage II Stage III
MPP A while values of its associated
marginal product remain nonnegative
B
Stage III
Is the range for which the use of
a variable input corresponds to
C negative values for its marginal
Labor
product
A B
Relationship between MPP & APP
curves

1. When MPP>APP, APP is increasing

2. When MPP=APP, APP is maximum
3. When MPP<APP, APP is decreasing

MPP
MPP/APP

APP

X
 Elasticity of production

 Ep=1 Ep=0
TPP/Y
TPP

Stage I Stage II Stage III

Ep>1 1>Ep>0 Ep<0
X

MPP>APP MPP<APP MPP<0 or

MPP/APP

-ve

APP
 Technology and the production
function
TPP/Y

Y2
TPP2
Y1
TPP1
Y*

X2 X1 X* X
Quantity of Total Marginal Average
labor (L) product product product
(TPP) (MPP) (APP)
0 0
1 50
2 110
3 390
4 520
5 580
6 630
7 650
8 650
9 640
Quantity of labor (L) Total product (TPP) Marginal product Average product
(MPP) (APP)
0 0
1 50 50 50.00
2 110 60 55.00
3 390 280 130.00
4 520 130 130.00
5 580 60 116.00
6 630 50 105.00
7 650 20 92.86
8 650 0 81.25
9 640 -10 71.11
TPP APP & MPP Curves

700 300
280
Total product (units per time period)

600 TPP 260

AP and MP (units per time period)

240
220
500
200
180
400 160
140
300 120
100 APPL
200 80
60
40
100
20 MPPL
0
0 -20 0 1 2 3 4 5 6 7 8 9 10
0 1 2 3 4 5 6 7 8 9 -40
Quantity of labor per time period, L
Quantity of labor per time period, L