Limited Input Supply

• Equi-marginal returns: equating marginal returns

• An input in limited supply should be allocated among all of

its alternative uses, so that the MVPs for the last units

allocated to each use are equal.

• multiply MPPY by Py = MVPs for each crop.
 EQUIMARGINAL RETURNS:
2400qsets of water, available in 4qsets per time
Irrigation MVP MVP MVP
(Ha-inch) Wheat (100ha) Sorghum (100ha) Cotton (100ha)

0
1200 1600 1800
4
800 1200 1500
8
600 800 1200
12
300 500 800
16
50 200 400
20
 Example
• Gilbert has unlimited equity to finance his farming operations,
available in E500 increments and he is considering three
possible enterprises to finance. The MVPs for each enterprise
on successive use of equity is shown below.
Equity invested Beans Cotton Flowers

First 500 500 350 350

Second 500 400 200 300

Third 500 250 180 250

Fourth 500 180 130 200

Fifth 500 110 100 180

Questions
1. If Gilbert had a limited amount of equity and no other
alternative enterprise, how much should he allocate to
each enterprise?
2. If Gilbert had borrowed capital repayable in a year at
15% interest, how much should he borrow and how
should it be allocated?
3. If Gilbert had borrowed only E1 000.00, how should he
allocate this capital among these enterprises? Does this
answer comply with the economic rule? What is the
income to Gilbert on this combination.

Due Tuesday 31 September 2021 …

 ECONOMIC
PRINCIPLES
CHOOSING INPUT & OUTPUT
COMBINATIONS

‘Substitution’
 CHOOSING
INPUT - OUTPUT
COMBINATIONS
FARM MANAGEMENT
INPUT SUBSTITUTION RATIO
 Isoquant –combination of input that
give same output

 Input Substitution Ratio =

change in amount of inputx replaced /
(change in amount of inputz added)
INPUT SUBSTITUTION RATIO

• Constant rate of substitution

• Decreasing rate of substitution

• No substitution possible - no other

combination
 INPUT SUBSTITUTION RATIO

• Input Price ratio =

Pz added ÷ Px replaced

• Input Substitution ratio =

Qty Inputz added ÷ Qty Inputx
replaced
DECISION RULE
 Finite
Input Substitution ratio = Input Price ratio

 Infinite
Input Substitution ratio < Input Price ratio

 Added cost < cost reduction= TC is lower ,

substitute = ISR >IPR

Table 8.1 pp127
Enterprise Combinations

• What to produce? What

combination of products will
maximize profit>
• Limited resource
• Substitution & trade off –
competitive enterprises
Enterprise Combinations
Production possibility curve –
possible enterprise combinations
produced from a given resource
i.e. 2ha land
Maximize profit – table 8.2- profit
combinations
Substitution & Profit Ratios

• Output substitution ratio =

changes Qty output lost / changes
Qty output
gained

• Output profit ratio =

Change Profit of output gained /
change Profit of output lost
DECISION RULE
Types of Substitution

 Supplementary Enterprises- production from

one can be increased without affecting the
other i.e winter pastures in dairy

 Complementary enterprises – increasing

production of one enterprise increases the
production from the other.
FARM MANAGEMENT
Cost Concepts in Economics
 17

Opportunity Cost

• The value of a product not produced because

an input was used for another purpose,

• The income that could have been received if

the input had been used in its most profitable
alternative use
 18

Everything Has an Opportunity Cost

Even if you use the input in its best possible

use, there is an opportunity cost for the item
you did not produce.

(In this case, opportunity cost will be

less than the revenue actually received.)
 19
Opportunity Cost of Applying Irrigation Water
Among Three Uses

Marginal Value Products ($)

irrigation water wheat sorghum cotton
(acre inches) (100 acres) (100 acres) (100 acres
4 $1 200 $1 600 $1 800
8 $800 $1 200 $1 500
12 $600 $800 $1 200
16 $300 $500 $800
20 $50 $200 $400
 20

How Does Opportunity Cost Relate

to the Equi-Marginal Principle?

• With the Equi-Marginal Principle, we are

choosing to produce one product instead

of another.
• The opportunity cost is the revenue given

up from the crop not produced.

 Opportunity Cost of Operator Time
/Labour

• Opportunity cost of operator's labor:

• What the operator could earn for that labor in best

alternative use

• Opportunity cost of operator's management:

• Difficult to estimate

• Total of opportunity cost of labor and opportunity cost

of management should not exceed total expected

salary in best alternative job
 farm management chapter 9 22

Opportunity Cost of Capital

• set as equal to what the capital would earn in

a no-risk savings account.

 Total Dollar value of the capital inputs is

estimated and multiplied by the interest rate for
a savings account.
farm management chapter 9 23
Expense Cash Non-cash
Depreciation X
Interest on Equity capital X

Interest on borrowed capital X

Value of operator labour X

Wages for hired labour X

Farm grown feed X

Purchased feed X
Owned land X
Cash rented land X
Seeds, fertilizer, fuel, repairs X

Property taxes, insurance X

farm management chapter 9 24

Cost Concepts
• Total Fixed Cost (TFC)
• Average Fixed Cost (AFC)
• Total Variable Cost (TVC)
• Average Variable Cost (AVC)
• Total Cost (TC)
• Average Total Cost (ATC)
• Marginal Cost (MC)
 25

Short Run and Long Run

• Short Run
• - the period of time during which the
quantity of one or more production
inputs is fixed and cannot be changed.

• Long Run
• - the period of time in which the amount
of all inputs can be changed.
 26

Fixed Costs

• exist only in the short run.

.
• In the short run, fixed costs must be paid

regardless of the amount of output produced.

• Fixed costs are not under the control of the

manager in the short run.

 27

Depreciation is a Fixed Cost

• Annual depreciation using the

straight-line method:

Original Cost — Salvage Value

Useful Life
 28

Interest is a Fixed Cost

Cost + Salvage Value

Interest = r
2

r = the interest rate

 29

Other Fixed Costs

 Property taxes and insurance

 Some repairs may be fixed costs, if they are

for maintenance.
• Machinery repairs = variable costs,

• Building repairs = fixed costs.

 30

Computing Total Costs

• Total Fixed Cost (TFC): The sum of all

fixed costs

• Total Variable Cost (TVC): The sum of

all variable costs

• Total Cost (TC) = TVC + TFC

 31

Average and Marginal Costs

• Average Fixed Cost (AFC): TFC/Output

• Average Variable Cost (AVC): TVC/Output

• Average Total Cost (ATC or AC): TC/Output

• Marginal Cost: TC/ Output

• or TVC/ Output
 32

Illustration Of Cost Concepts Applied To A Stocking

Rate Problem

Number Output MPP TFC TVC TC AFC AVC ATC MC MR

of Steers Cwt Beef ($) ($) ($) ($) ($) ($) ($) ($)
0 0 *** 5 000 0 5 000 *** *** *** *** ***
10 72 7.2 5 000 4 950 9 950 69.44 68.75 138.19 68.75 87.50
20 148 7.6 5 000 9 900 14 900 33.78 66.89 100.68 65.13 87.50
30 225 7.7 5 000 14 850 19 850 22.22 66.00 88.22 64.29 87.50
40 295 7.0 5 000 19 800 24 800 16.95 67.12 84.07 70.71 87.50
50 360 6.5 5 000 24 750 29 750 13.89 68.75 82.64 76.15 87.50
60 420 6.0 5 000 29 700 34 700 11.90 70.71 82.62 82.50 87.50
70 475 5.5 5 000 34 650 39 650 10.53 72.95 83.47 90.00 87.50
80 525 5.0 5 000 39 600 44 600 9.52 75.43 84.95 99.00 87.50
90 570 4.5 5 000 44 550 49 550 8.77 78.16 86.93 110.00 87.50
100 610 4.0 5 000 49 500 54 500 8.20 81.15 89.34 123.75 87.50
 33

Application of Cost Concepts

Cost concepts can be used in

1.Short–run Decision Making

2.Long-run Decision Making.

 34

Production Rules for the Short Run

1. If Price > ATC, produce and make a profit.

2. If ATC>Price>AVC produce and minimize

losses.

3. If AVC> Price, do not produce and limit your

loss to your fixed costs.

 35

Logic Behind These Rules

• Fixed costs must be paid whether you produce or

not in any given year.
• They are therefore irrelevant to the production
decision.
• Consider only variable costs.
 If you can cover those, you should produce.

If you cannot can cover , you don’t produce.

 36

Example: Producing at a Loss

Fixed Costs are $10,000. At the point where

MR=MC, TVC are $8,000 and TR is $12,000.

$10,000
•If I don’t produce, I will have a loss of _______

•If I do produce, I will have a loss of $6,000

_________

I should produce to minimize losses.

 37

If Losses Exceed Fixed Costs

Fixed Costs are $10,000. At the point where

MR=MC, TVC are $15,000 and TR is $12,000.

$10,000
•If I don’t produce, I will have a loss of _______

$13,000
•If I do produce, I will have a loss of _________

I should not produce

 38

Illustration of short-run production decisions

 39

Don’t Produce
ATC

AVC

loses more than

fixed cost
MR = Price
MC
Output
 40

Produce at a Loss
ATC

AVC
loses less than
fixed cost MR = Price

MC
Output
 41

Produce at a Profit
ATC
per-unit profit
AVC
MR = Price

MC
Output
 42

Production Rules for the Long Run

• Price > ATC. Continue to produce at the point

where MR=MC.

• Price < ATC. Stop production and sell fixed

assets.
 43

Economies of Size

1. What is the most profitable farm size?

2. Can larger farms produce food and fiber more

cheaply?

3. Are large farms more efficient?

4. Will family farms disappear and be replaced by

corporate farms?

5. Will farm numbers continue to fall?

 44

Farm Size In The Short Run

 Measuring Economies of Size

is measured as the output of a single

• Size
product.
• Output can be increased in the short run only by
intensifying production

• Long run:
size measured by ∆ farm size ratio
 46

Economies of Size in Long-run

% Change in Costs
=
% Change in Output Value

Ratio value Type of costs

<1 Decreasing
=1 Constant
>1 Increasing
∆ Farm Size Ratio = Long run

Ratio value Types of Costs Farm scale

<1 Decreasing Increasing returns
to scale

=1 Constant Constant returns

to scale

>1 increasing Decreasing

returns to scale
 48
Possible Size-cost Relations Long-run Average
Cost Curve

<1 >1
=1
 49

Causes of Economies of Size

1. Full utilization of existing resources

2. Technology
3. Use of specialized resources
4. Decreasing input prices
5. Higher output prices
6. Management
farm management chapter 9 50

Causes of Diseconomies of Size

1. Management

2. Labor supervision

3. Geographical dispersion

4. Special problems of large livestock

operations
 51

Two Possible LRAC Curves

ENTERPRISE
BUDGETING
 Budgeting

• Testing it out on paper before committing

resources to a plan
- new/existing plan
• Forward planning tool,
• best estimate profitability/ feasibility of plan

budgeting + economic principles = Right

decision
 Enterprise Budgeting
• Estimate potential revenue, expenses & profit of
an enterprise
• Based of
• type of farming – crops/LSU
• Levels of production
• Types of technology

• Base unit is /ha crops or /head

• Purpose is to estimate projected costs, returns,
profit/unit enterprise pp176
• Whole farm plan = several enterprise budgets
to be undertaken in the farm
 An Enterprise Budget

• Name of enterprise
• Year projected
• Income/revenue
• Costs: variable/fixed
• Variable: pre-harvest, harvesting, post-harvest
• Fixed costs: ownership/indirect expenses
• Gross margin
• Estimated profit/ return to management = economic
profit
• Cost & Return Estimation: uses actual costs
Crop Budget

• Tillage & agronomic practices

• Input levels & application rates
• Seeding rate
• Types & amount of herbicides
• Type & number of tillage operations
• P178
 Components
• Revenue • Fixed expenses
• Variable costs • Depreciation
• Inputs • Machinery interest
• Fuel & lubricants • Taxes & insurance
• Machinery repairs • Land charge
• labor • Profit/return to
• Interest management
• Income above variable Double cropping
costs Storage , transport &
marketing costs
Establishment costs
 Capital Recovery

• Combines depreciation & interest into one

(TD * amortization factor) + ( salvage

value*interest rate)
• Amortization factor based on interest are and

lifespan of machinery
• CR is the money required at the end of each year to

pay interest on the remaining value of the machine &

recover the capital lost through depreciation
Livestock Enterprise Budget
• Unit: one head, litter of swine, 1cow, 100birds,
• Periods: year, per batch
• Multiple products: identify all,
• Breeding herd replacement: 10% replacement rate,
purchased
• Pasture & feed: farm-raised/purchased,
establishment & maintenance cost of pasture, land
costs,
• Livestock facilities: repairs, fuel, depreciation,
interest, taxes, insurance,
• Machinery & equipment
pp183
Interpreting Enterprise Budgets

• Economic VS. Accounting profit

• Economic profit:
• Of Zero: all factors are earning only their opportunity costs not
more
• +ve profit: one or more factors are earning more than their
opportunity costs
• -ve profit: all factors are earning less than their opportunity costs
 Analyzing Enterprise Budgets

1. Cost of production: average total cost of producing one

product TC/yield

2. Break-even yield: yield necessary to cover all costs at a

given output price. TC/output price

3. Break-even price: output price needed to cover all costs at

a given output level. TC/ expected yield

p187
 62

Next Lessons

1.Enterprise & partial budgeting

2.Farm analysis [Income & balance sheet analysis]
3.Capital & use of credit
4.Investment analysis