ECON 304

Farm Management, Production and

Resource Economics
Credit hrs: 2 (1+1)
 FARM MANAGEMENT
 Farm Management comprises of two words i.e. Farm and
Management.

 Farm means a piece of land where crops and livestock enterprises

are taken up under common management and has specific
boundaries.

 Management is the art of getting work done out of others working in a

group.

 Management is the process of designing and maintaining an

environment in which individuals working together in groups
accomplish selected aims.
 Farm business management has assumed greater
importance not only in developed and commercial agriculture
all round the world but also in developing and subsistence
type of agriculture.

 A farm manager must not only understand different methods

of agricultural production, but also he must be concerned
with their costs and returns.

 He must know how to allocate scarce productive resources

on the farm business to meet his goals and at the same time
react to economic forces that arise from both within and
outside the farm.
The need for managing an individual farm arises due to the following
reasons:

i) Farmers have the twin objectives, viz., maximization of farm profit

and improvement of standard of living of their families.

ii) The means available to achieve the objectives, i.e., the factors of
production, are scarce in supply.

iii) The farm profit is influenced by biological, technological, social,

economic, political and institutional factors.

iv) The resources or factors of production can be put to alternative

uses.
 Farm management is concerned with resource allocation.

 On one hand, a farmer has a set of farm resources such as land,

labour, farm buildings, working capital, farm equipments, etc. that are
relatively scarce.

 On the other hand, the farmer has a set of goals or objectives to

achieve may be maximum family satisfaction through increasing net
farm income and employment generation.

 In between these two ends, the farmer himself is with a specific

degree of ability and awareness.

 This gap is bridged by taking a series of rational decisions in respect

of farm resources having alternative uses and opportunities.
 DEFINITIONS OF FARM MANAGEMENT

1. The art of managing a Farm successfully, as measured by the test of

profitableness is called farm management. (L.C. Gray)

2. Farm management is defined as the science of organisation and

management of farm enterprises for the purpose of securing the
maximum continuous profits. (G.F. Warren)

3. Farm management is a branch of agricultural economics which deals

with wealth earning and wealth spending activities of a farmer, in
relation to the organisation and operation of the individual farm unit for
securing the maximum possible net income. (Bradford and Johnson)
 NATURE OF FARM MANAGEMENT

 Farm management deals with the business principles of

farming from the point of view of an individual farm.
 Its field of study is limited to the individual farm as a unit and
it is interested in maximum possible returns to the individual
farmer.
 It applies the local knowledge as well as scientific finding to
the individual farm business.
 Farm management in short be called as a science of choice
or decision making.
 OBJECTIVES
1. To examine production pattern and resource use on the
farm.
2. To identify the factors responsible for the present
production pattern.
3. To determine the conditions of optimality in the resource
use and production pattern.
4. To analyze the extent of sub-optimality in the resource
use.
5. To suggest ways and means in getting the present use of
resources to optimality.
 SCOPE OF FARM MANAGEMENT
 Farm Management is generally considered to be
MICROECONOMIC in its scope.
 It deals with the allocation of resources at the level of individual farm.
 The primary concern of the farm management is the farm as a unit.
 Farm Management deals with decisions that affect the profitability of
farm business.
 Farm Management seeks to help the farmer in deciding the problems
like what to produce, buy or sell, how to produce, buy or sell and how
much to produce etc.
 It covers all aspects of farming which have bearing on the economic
efficiency of farm.
 RELATIONSHIP OF FARM MANAGEMENT WITH OTHER
SCIENCES
 The Farm Management integrates and synthesises diverse piece of
information from physical and biological sciences of agriculture.
 The physical and biological sciences like Agronomy, animal
husbandry, soil science, horticulture, plant breeding, agricultural
engineering provide input-output relationships in their respective areas
in physical terms i.e. they define production possibilities within which
various choices can be made. Such information is helpful to the farm
management in dealing with the problems of production efficiency.
• Farm Management as a subject matter is the application of business
principles n farming from the point view of an individual farmer.
• It is a specialised branch of wider field of economics.
• The tools and techniques for farm management are supplied by
general economic theory.
• The law of variable proportion, principle of factor substitution,
principle of product substitution are all instances of tools of economic
theory used in farm management analysis.
• Statistics is another science that has been used extensively by
the agricultural economist. This science is helpful in providing
methods and procedures by which data regarding specific farm
problems can be collected, analysed and evaluated.
• Psychology provides information of human motivations and
attitudes, attitude towards risks depends on the psychological
aspects of decision maker.
o Sometimes philosophy and religion forbid the farmers to grow
certain enterprises, though they are highly profitable. For
example, islam prohibits muslim farmer to take up piggery while
Hinduism prohibits beef production.

o The various pieces of legislation and actions of government affect

the production decisions of the farmer such as ceiling on land,
support prices, food zones etc.

o The physical sciences specify what can be produced; economics

specify how resources should be used, while sociology,
psychology, political sciences etc. specify the limitations which
are placed on choice, through laws, customs etc.
Farm Management Decisions
Factors Influencing Farm Management Decisions
Farm management decisions continuously undergo a change overtime
because of the changing environment around the farm, farmer and his
family. The factors which influence the decision making process are:

a)Economic factors like prices of factors and products.

b)Biological characteristics of plants and animals.

c) Technological factors like technological advancements in the field of

agriculture and suitability of different varieties and farm practices to
varied agro – climatic conditions.
d) Institutional factors like availability of infrastructural facilities which
include storage, processing, grading, transport, marketing of inputs
and outputs, etc, government policies on farm practices, input
subsides, taxes, export and import, marketing, procurement of
produces and so on.
e) Personal factors like customs, attitude, awareness, personal
capabilities and so on. One or more changes of the above categories
in the environment around the farmer may cause imperfections in
decision-making. The process of decision making, therefore, has
tombe dynamic so as to adjust in such changes.
 Decision Making Process
Every farmer has to make decisions about his farm organization and
operation from time to time. Decisions on the farms are often made by
the following three methods:
a) Traditional method: In this method, the decision is influenced by
traditions in the family or region or community.
b) Technical method: In this method, the decisions require the use of
technical knowledge. For example, a decision is to be made about the
quantity of nitrogen requirement to obtain maximum yield of paddy.
c) Economic method: All the problems are considered in relation to the
expected costs and returns. This method is undoubtedly the most useful
of all the methods for taking a decision on a farm.
 Steps in Decision Making

The steps in decision - making can also be shown schematically

through a flow chart. The important steps involved in the decision-
making process are formulating objectives and making observations,
analyses of observations, decision-making, action taking or execution
of the decisions and accepting the responsibilities. The evaluation and
monitoring should be done at each and every stage of the decision-
making process.
 Farm Resource Management
Farm
It is a piece of land, where crop s and livestock enterprises are taken
up under single management and has specific boundaries.

Size of Farm
• The size of farm generally understood in terms of physical area,
volume of production and value of production.
• In general the size of farm refers to physical area, but in terms of
economics this refers to either the volume of production or value of
production.
• Types and system of farming refer to the nature and degree of
products and their combination and various methods followed in the
production of the same.
1. SPECIALIZED FARMING
• When a farm business unit derives more than 50 per cent of its
income from a single enterprise it is called as a specialized farm.

• This means that among the possible crops or livestock enterprises

taken up by a farmer, one particular crop or livestock enterprise
contributes more than 50 per cent of the income.

• The reasons for specialized farming are;

1) assured income from the enterprise;
2) Its suitability to the area;
3) Its relative profitability, etc.

• For example, paddy farming, sugarcane farming, tobacco farming,

poultry, sheep farming, fish farming, etc.
Advantages
1. Better Utilization of Land: Land can be put to most productive use, by opting
the enterprise that is best suited. A given type of land no doubt allows options
for alternative crops; still there is a possibility of a particular crop capable of
rewarding the farmer with better income.
2. Better Management: Specialization since is bestowing attention on a
particular enterprise, it reduces the pressure on the farmer to care for several
enterprises. Naturally, it reduces the wastage of resources.
3. Less Requirement of Equipment: The farmer can carry on the business
activity with the equipment that is required for the chosen enterprise. There are
no pressing requirements to equip the farm with a variety of equipment.
4. Increase in Skill of the Farmer: The efficiency of the farmer
increases as he can concentrate on one enterprise. His experience
in the enterprise sharpens his skills in running the enterprise.
5. Allows Better Marketing: On marketing front, the farmer is
better placed. He is saved from the pressure of finding market if he
were to sell diversified products. It allows for better marketing
functions i.e., assembling, transport, grading, etc.
Disadvantages
1. Failure of crop: The farmer runs the risk of heavy loss in
case of crop failure. There is no possibility of compensation.
This is the biggest drawback of specialized farming.
2. Non-utilization of Productive Resources: Since the
farmer confines to one or few enterprises, the various farm
resources like land, water, labour, capital, etc., may not be
fully utilized. In view of the limited enterprises, some of the
resources may remain untapped or under-utilized.
3. Affect on Soil Health: Continuous raising of one crop or
few crops may be exerting greater pressure on soil health.
This practice does not allow crop rotation, thereby affecting
the soil health.
2. DIVERSIFIED FARMING
• It is also known as general farming.
• It means a number of enterprises are taken up on the farm at the same time.
• There is no much significance for a single enterprise under this situation.
• No single enterprise contributes as high as 50 per cent of the total income.
Advantages
1. Better Utilization of Farm Resources: In view of the diversified cropping and crop
rotations, farm resources are better utilized compared to specialized farming.
2. Reduction of Farm Risks: As a variety of crops are found, failure of one or two
crops will not much affect the income from farming.
3. Flow of Income: The farmer enjoys the advantage of deriving regular income, as
different crops are grown.
Disadvantages
• Ineffective Supervision: The presence of a number of enterprises on the farm
will stand in the way of the farmer in bestowing effective supervision.
Effectiveness can be found when there is a limit to the number of enterprises.
This is likely to affect the farm economy.
• Less Possibility for Maintaining a Variety of Implements and Machinery: It
becomes expensive to purchase and maintain the required suitable implements
and machinery for the various enterprises taken up on the farm.
• Probable Marketing Insufficiencies: The growing of a variety of crops is likely
to bring in problems on marketing front. The farmers have to search for
markets.
3. MIXED FARMING
• It represents a type of farming in which crop production and livestock production
are combined to sustain and satisfy as many needs of the farmer as possible.
• There are limits specified regarding contribution of livestock production, poultry,
fisheries, and bee keeping, etc., to the gross income on the farm. These
enterprises are 49 supposed to contribute at least 10 per cent of gross income.
However, this contribution should not exceed 49 per cent.
• It facilitates the application of organic manuring to soil, thus helping the
maintenance of soil health.
• It provides employment to the farmer and his family throughout the year.
• Agricultural by-products are properly used in mixed farming.
• It further provides a sort of stability to the farm business.
4. DRY FARMING
• Growing of crops entirely under rainfed conditions is known as dry land
agriculture.
• Depending on the amount of rainfall received, dry land agriculture is categorized
into dry farming, dry land farming and rainfed farming.
• Dry farming means cultivation of crops in areas where rainfall is less than 750
mm per annum. Crop failure is the most common due to prolonged dry spells
during the crop period. Dry farming regions are equivalent to arid regions and
moisture conservation practices are important in this region.
• Dry land farming is the cultivation of crops in regions with an annual rainfall of
more than 750 mm. Dry spells during crop period occurs, but crop failures are
relatively less frequent. Moisture conservation practices are necessary for crop
production.
• Rainfed farming is crop production in regions with an annual rainfall of more than
1150 mm. It is practiced in humid regions where crop failures are rare and
drainage is the important problem.
• In dry farming and dry land farming, emphasis is on soil and water
conservation, sustainable crop yields and limited fertilizer use according to soil
moisture availability.
• In rainfed agriculture the emphasis is on disposal of excess water, maximum
crop yield, and high levels of inputs and control of water erosion.
5. RANCHING
• Grazing of livestock on public pastures is called ranching.
• These lands are not fit for cultivation.
• Ranching is followed in Australia, America and Tibet.
 FACTORS INFLUENCING TYPES AND SIZE OF FARM

1) Physical Factors
1. Climate: It includes sunshine, rainfall, wind, length of sunlight, etc. These
factors predominantly influence the choice of crops, thereby affecting the type of
farming. Crops like paddy and sugarcane requires substantial water while
others like oilseeds; millets and pulses can withstand low rainfall.
2. Soil: The type of soil, depth of soil and fertility status of the soil affects the
selection of crops. Deep soils facilitate production of a variety of crops bringing
prosperity to 50 agriculture. If soils are fertile, manurial costs can be reduced
thereby the cost of cultivation.
3. Topography: It means the general contour of the land, whether it is hilly or plain.
Temperatures are low and growing seasons are shorter at higher elevation and
therefore more suitable for establishment of plantation crops like tea, coffee, etc.
Contour also determines the type of machinery that can be used and the rate of soil
erosion, which in turn influences the choice of crop.
2) Economic Factors
1. Relative Profitability: Given the option of choosing among several crops in an
area, farmers first look into the relative profitability of a given enterprise. A particular
enterprise if found to be relatively profitable, farmers are inclined to go for it. In a
dynamic situation the options are bound to change with changes in the relative
profitability of crops. These changes occur in view of changes in yields, changes in
prices, risk factors, introduction of incentives, crop restrictions, technology, etc.
2. Availability of Funds: Different enterprises require different levels of funds. For
example, commercial enterprises like sugarcane, chillies, onion, prawn culture,
etc., require large amount of funds over enterprises like oilseeds, millets, etc.
Therefore availability of funds determines the type of farming.

3. Availability of the Inputs: All the inputs like labour, seed, fertilizer, etc., should
be available as per the requirement. If labour shortages are common in an area
during peak periods, certainly the farmers do keep this in mind in the selection of
the enterprises. Timely availability of other inputs in required quantities also
influences their decision with regard to selection of enterprises.
4. Marketing Arrangements: The marketing facilities available for the products
are also given due weightage in the selection of enterprises. Mere assured output
with inadequate marketing arrangements will not influence the farmers to opt for a
given enterprise and
5. Personal Choices: Apart from aforesaid factors individual farmer's likes and
dislikes have a say, in the selection of enterprises.
 BASIC CONCEPTS AND TERMS

It is a piece of land, where crop s and livestock enterprises are

Farm taken up under a single management and has specific
boundaries.
Farm – firm It is an economic unit which is run under one management.

Land holding The total area of land owned by an individual or joint family
whether cultivated by the family or rented out.

Operational Total land area held under a single management for the purpose
holding of cultivation. It excludes any land leased-out to another person
but includes any land leased-in.
It is defined as one which could provide a reasonable standard of
Economic holding living to the cultivators and give full employment for a
family of normal size.
Marginal farmer Farmer owning up to 1 ha land is called marginal farmer.

Small farmer Farmer owning more than 1 ha to 2 ha land is called small farmer.

Medium farmer Farmer owning more than 2 ha to 4 ha land is called medium farmer.

Large farmer Farmer owning more than 4 ha land is called large farmer.
 Anything that aids in production is called resources. They
Resources physically enter the production process to transform into output.
Examples: inputs such as seeds, fertilizers, water, etc.
The work done by person, machine or livestock is called resource
Resources services service. Here only services are available for production.
Examples: services of land, labour, machinery, livestock etc.

Resources which remain unchanged irrespective of the level of

Fixed resources / production are called fixed resources. The costs which are
Fixed cost associated with fixed resources are called fixed costs.
Examples: land, building, permanent labour, implements etc.

Resources which changed with the level of production are called

Variable resource / variable resources. The costs which are associated with variable
Variable cost resources are called variable costs. Examples: seeds, fertilizers,
casual labour, etc.
 The resources which cannot be stored and should be used
Flow resources as and when they are available. Examples: services of
land, labour, machinery etc.
Stock resources The resources which can be stored and should be used as
and when required. Examples: seed, fertilizers etc.
It is the resource which is used only once in production.
Mono-period resource
Examples: seeds, fertilizers, petrol, diesel, electricity, etc.
It is the resource which is used in the production process
Poly-period resource over several periods. Examples: land, labour, machinery,
implements etc.
Variable Any input which can have different quantities/values in the
production process.
It is a variable whose value does not depend on other
Independent variable variable. Such variables influence the dependent variable.
Ex: labour, seed, fertilizer, land etc.
Dependent variable A variable that is governed by another variable. Example:
Crop output.
Product It is an outcome of the production process. Ex: Paddy, wheat,
sugarcane, milk etc.

The transformation of inputs into outputs is called production.

Production
In economics, production means creation of utilities.

Production function A systematic and mathematical way of measuring the

relationship between input and input.

Short-run The planning period during which one or more resources are
production function fixed.

Long-run
production function It is a planning period during which all resources are varied.
 Productivity denotes the efficiency with which various inputs are converted
in to products.
Productivity It is a measurement of output per unit of the factor used.
Productivity = Total Output
Total input

Technical coefficient The amount of input used per unit of output is called technical coefficient.

Efficiency It means using resources most effectively to satisfy the farmer’s needs and
goals.
It is the ratio of output to input. It can be achieved if the same output can be
Technical efficiency produced using fewer inputs.
Technical Efficiency means output produced using the fewest possible
inputs.

It is the expression of technical efficiency in monetary value by attaching

prices. In other words, the ratio of value of output to value of input is called
Economic efficiency /
economic efficiency. It is also called Productive efficiency. It can be
Productive efficiency
achieved where the same output could be produced at lower cost.
Productive Efficiency means output produced at the lowest possible cost.
Allocative efficiency It occurs where the goods and services being produced match
the demand by consumers.

It occurs where the private and social cost of production is

Social efficiency equal to the private and social benefits derived from their
consumption. It is a measure of social welfare.

It is a yardstick indicating which of the two or more

Choice indicator alternatives maximizes a given end. Choice indicator always
expressed in ratio. Ex: Price ratio, MRTS, MRPS, etc.

The expenditure incurred on all inputs and input services in

Cost of cultivation raising a crop on a unit area, is referred to as cost of
cultivation. Ex: costs in Rs/ha, Rs./acre, etc.

Cost of production The expenditure incurred in producing a unit quantity of output

is called cost of production. Ex: Cost in Rs/quintal, Rs/kg, etc.
 It indicates a level of production where net profit is maximum
Optimality
(output may be or may not be maximum).

It is assumed to be the standard motive of firms in the private sector. Profit

maximisation occurs where Marginal Cost = Marginal Revenue (MC =
Profit maximisation MR). The firm will continue to increase output up to the point where the
cost of producing one extra unit of output is equals to the revenue received
from selling that last unit of output.

Marginal Cost (MC) It is the cost of producing one extra unit of production.

Marginal Revenue It is the addition to total revenue as a result of producing one more unit of
(MR) output. It is the price received from selling that extra unit.

Farm entrepreneur He is the person who organizes and operates the farm business and bears
responsibility of the outcome of the business.

He is a person appointed by the entrepreneur to manage or supervise

Farm manager the farm business and paid for his services. He carries the instruction of
the entrepreneur.
 BASIC TERMS

Total Product It is the sum of output which can be produced by using various units of inputs.
(TP) It is denoted as Y

It is the additional quantity of output, added by an additional unit of input i.e., the
Marginal change in output as a result of change in the variable input.
Product (MP) MP = Change in Total Product = ∆Y
Change in Input level ∆X

It refers to the average productivity of a resource. It is the ratio of total product

Average to the total input used in producing that amount of product.
Product AP = Total Product (TP) = Y
Total Inputs (X) X
Elasticity of It is defined as percentage change in output as a result of percentage
Production change in input. It can also be defined as ratio of MP and AP.
(Ep)
% change in Output MP
Ep = or
% change in Input AP
Solution:
∆Y/Y*100 ∆Y/Y ∆Y ∆X ∆Y X
Ep = = = ÷ = *
∆X/X*100 ∆X/X Y X Y ∆X

∆Y X ∆Y Y
= ---- * ---- = ----- ÷ ----
∆X Y ∆X X
We know that ∆Y/∆X = MP, and Y/X = AP
MP
Therefore, Ep = ------
AP
 LAWS OF RETURNS

There is said to be increasing, decreasing or constant

returns according to the marginal returns rise, fall or remain
constant” as the quantity of a factor of production is
increased.
 LAW OF INCREASING RETURNS
Every additional or marginal unit of input adds more to total product than the
previous unit i.e., addition to the total product is at an increasing rate.

Input Output Marginal Input Marginal Output Marginal Rate of Return

(X) (Y) (∆X) (∆Y) (∆Y/∆X)

0 0 - - -

5 25 5 25 5

10 75 5 50 10

15 150 5 75 15

20 250 5 100 20

25 400 5 150 30
 The slope of the curve will go steeper and steeper with the added
unit. i.e., its shape gets convex to the origin. This relationship can also
be expressed as:
∆Y1 < ∆Y2 <∆Y3 < -------<∆Yn
∆X1 ∆X2 ∆X3 ∆Xn
 The law of increasing returns states that the ratio ∆Y/∆X will go on
increasing as more and more units of input are added
 This law operates in the economies where non-human and non-animal
power resources (water and wind power, steam, electricity, atomic
energy, etc.) are used or where automatic self-adjusting mechanism is
applied.
 In agriculture, this law is normally observed at an initial stage of
production.
 LAW OF DECREASING RETURN
Every additional or marginal unit of input adds less to total product than the
previous unit i.e., addition to the total product is at a decreasing rate.

Marginal Marginal Marginal Rate of

Input (X) Output (Y) Input (∆X) Output (∆Y) Return (∆Y/∆X)

0 50 - - -
10 140 10 90 9
20 210 10 70 7
30 260 10 50 5
40 300 10 40 4
50 330 10 30 3
60 350 10 20 2
 The slope of the curve will concave to the origin with the added
unit. This relationship can also be expressed as:
∆Y1> ∆Y2> ∆Y3 > ……..> ∆Yn
∆X1 ∆X2 ∆X3 ∆Xn
• The law of decreasing returns states that the ratio ∆Y/∆X will go
on decreasing as more and more units of input is added.
• This law operates widely in agriculture, mining, fisheries, building
industries, etc. where human and animal power resources are
widely used.
 LAW OF CONSTANT RETURNS

Every additional or marginal unit of input adds an equal quantity to total

product i.e., addition to the total product is at a constant rate.

Marginal Input Marginal Marginal Rate of Return

Input (X) Output (Y) Output (∆Y) (∆Y/∆X)
(∆X)

0 0 - - -
1 5 1 5 5
2 10 1 5 5
3 15 1 5 5
4 20 1 5 5
5 25 1 5 5
6 30 1 5 5
This production function is a straight line or linear relationship having the
same slope throughout its entire range. This relationship can also be expressed
as:

∆Y1= ∆Y2= ∆Y3= ------ = ∆Yn

∆X1 ∆X2 ∆X3 ∆Xn

• The law of constant returns states that the ratio ∆Y/∆X will remain
constant as more and more units of input is added.

 This law operates in manufacturing industries where non-human like

machineries play greater role.
• In actual, these three laws are only three aspects of one law, viz.,
Law of Variable Proportion. It represents three different stages of
the same law. It is also known as Law of Diminishing Marginal
Return.
 FACTOR - PRODUCT RELATIONSHIP
Classical Production Function

 It examines the relationship between one variable factor and output, keeping the
quantities of other factors fixed.
 It is a short-run production function.
 It explains the Law of Variable Proportion or the Law of Diminishing Marginal
Return.
DEFINITION
The Law of Variable Proportion states that as the proportion of one factor in a
combination of factors is increased, after a point, first the marginal and then the
average product of that factor will diminish. It is, therefore, known as Law of
Diminishing Marginal Return
PRODUCTION FUNCTION USED

Y = f (X1 | X2, X3,…, Xn).

Where, Y = output;
X1 = variable input;
X2, X3,…., Xn = fixed inputs.

OBJECTIVE
• The main objective of this relationship is to find out optimum level of
resource use or
resource optimization.
• The management problem associated with this analysis is how much to
produce?
 Output (TP) Marginal Marginal MP
Input (X) Input (∆X) Output (∆Y) AP (Y/X) Remarks
(Y) (∆Y/∆X)

0 0 - - - -
1 2 1 2 2.00 2 Increasing at
2 5 1 3 2.50 3 increasing rate
3 9 1 4 3.00 4
4 14 1 5 3.50 5 Increasing at
5 19 1 5 3.80 5 constant
rate
6 23 1 4 3.83 4
7 26 1 3 3.71 3
8 28 1 2 3.50 2 Increasing at
decreasing rate
9 29 1 1 3.22 1
10 29 1 0 2.90 0

11 28 1 -1 2.54 -1 Decreasing
12 26 1 -2 2.16 -2 (negative return)
 Nature of TP Curve Nature of MP Curve Nature of AP Curve
TP increasing at increasing rate
 MP increasing
TP increasing at decreasing rate  AP increasing
 MP attains maximum
TP riches at maximum and  AP attains maximum
 MP remains constant
remains constant  AP is decreasing
 MP decreasing
TP decreasing

Relationship between TP and MP

 When TP increasing at increasing rate, MP also increasing.
 When TP increasing at decreasing rate, MP also decreasing.
 When TP is maximum or remain constant, MP=0
 When TP decreasing, MP becomes negative.
 When TP changes its curvature (from increasing rate to decreasing rate), MP
is maximum. This point is known as point of inflection.
 Relationship between MP and TP Relationship between MP and AP
 MP > 0, TP increasing  When MP > AP, AP increasing; Ep >1
 MP = 0, TP maximum  When MP = AP, AP is maximum; Ep=1
 MP < 0, TP decreasing  When MP < AP, AP decreasing; Ep<1
 THREE ZONES OF PRODUCTION FUNCTION
The classical production function can be divided into three zones.
Zone-I: Stage of increasing returns
 This region starts from the point of origin and ends where the average
product reaches its highest (maximum) or where MP=AP.
 During this stage, the TP, AP and MP are increasing.
 It is notable that the MP in this stage increases but in a later part it starts
declining. Though MP declining, it is greater than the AP.
 AP increases throughout this region indicating that the efficiency of all the
variable inputs keeps on increasing.
Zone-II: Stage of decreasing returns
 This region starts where 1st zone ends. i.e. MP=AP and extends to the point
where MP=0 or TP is maximum.
 In this zone, the TP continues to increase but at a diminishing rate.
 The MP and the AP are declining but are positive.
Zone-III: Stage of negative returns
 This region starts when MP crosses zero and becomes negative.
 In this zone the MP becomes negative.
 The TP and the AP are declining.
 SUMMARY
Zone - I Zone - II Zone – III
From origin to AP=MP From AP=MP to MP=0 From MP=0 to onwards

TP is increasing but at a TP, AP & MP all are

TP, AP & MP all are
decreasing rate. MP & AP decreasing. MP becomes
increasing
decreasing but are positive. negative.
Ep > 1 Ep < 1 Ep < 0
Stage of increasing return Stage of decreasing return Stage of negative return

Irrational zone Rational zone Irrational zone

Zone of underutilization Zone of optimum level of Zone of overutilization of
of resources resources resources
 FACTOR - FACTOR RELATIONSHIP
Law of Factor Substitution

INTRODUCTION
 Any production activity requires different inputs to produce a given quantity of
output. There are many ways of combining these resources in production process.
 Farm production facilitates the substitution of resources. For example, a farmer
producing crop does make a choice between manures and chemical fertilizers,
human labour and machinery, etc. Similarly a dairy farmer has to decide upon
the quantity of fodder and concentrate to arrive at feed ration.
 The factor-factor relationship is explained by the law of factor substitution.
 In this relationship, two factors or inputs are varied and the output is kept
constant.
 PRODUCTION FUNCTION USED
Y = f (X1, X2 | X3, X4, … , Xn)
Where, Y = a fixed level of output; X1, X2 =
variable inputs.
X3, X4,…., Xn = inputs which remains constant.
OBJECTIVE
 The objective here is to find out the most appropriate combination of
inputs that costs the least amount in producing a given level of output or
cost minimization.
 The management decision associated with this analysis is how to
produce? i.e. which combination of two factors to be used?
 ISO-QUANT
 Iso means equal and quant means quantity.
 The curve representing all combinations of X1 and X2 that produce the equal quantity of
output is called an iso-quant .
 It is also termed as iso-product curve or product indifference curve.

Example: The output of paddy amounting to 1000 kg/acre can be produced using the different
combinations of two inputs viz., Manure (X1) and Urea (X2) as under.

Combination Manure (X1) (qty. in cart-load/acre) Urea (X2) (qty. in kg/acre)

A 1 200
B 2 125
C 3 80
D 4 50
E 5 30
F 6 17
G 7 10
Characteristics or Properties of an iso-quant
 Iso-quant is downward sloping from left to right i.e. it is negatively sloped.
 Iso-quant is convex to the origin.
 Iso-quant placed above represent higher output and vice-versa.
 Iso-quants are non-intersecting.
MARGINAL RATE OF TECHNICAL SUBSTITUTION (MRTS)
 It is the rate of exchange between two inputs which are equally preferred.
 It indicates the absolute amount by which one input is decreased or replaced to add a unit of another
input.
 Alternatively, the quantity of one input to be sacrificed or given up in order to gain another input
by one unit, in process of substitution.
MRTS = Quantity of replaced input
Quantity of added input

MRTS of X1 for X2 is written as : MRTSX1X2 = ∆X2 ÷ ∆X1 ; and

MRTS of X2 for X1 is written as : MRTSX2X1 = ∆X1 ÷ ∆X2
Combi- Manure (X1) Urea (X2) MRTSX1X2 MRTSX2X1
∆X1 ∆X2
nation (cart-load/acre) (kg/acre) = ∆X2 ÷ X1 = ∆X1÷∆X2

A 1 200 - - - -
B 2 125 1 75 75 0.013
C 3 80 1 45 45 0.022
D 4 50 1 30 30 0.033
E 5 30 1 20 20 0.050
F 6 17 1 13 13 0.077
G 7 10 1 7 7 0.143
 ISO-COST LINE

 Iso-cost line represents various combinations of two inputs that can be

purchased with the given amount of money.

 It is known as price line or budget line.

 It can be drawn by locating the end points of X1 and X2 that can be purchased
from the given amount of money.

 It plays an important role in determining the combination of factors that the

farmer should choose for production.
Suppose, a farmer has a fund of Rs. 1000 and he has to spend on two
inputs viz., X1 (Manure) and X2 (Urea). Price of X1 is Rs. 200/cart-load
and that of X2 is Rs. 5/kg. Given the prices of X1 and X2, he can
purchase a maximum 5 cart-load of Manure or 200 kg of Urea.
To draw Iso-cost line we need two extreme points X1 and X2 which can
be obtained as under:

X1 (cart-load) X2 (kg)
5 0
0 200

When these two points X1 (5,0) and X2 (0,200) are joined, we get
iso-cost line. Similarly, iso-cost line for budget of Rs. 750 and Rs.
1250 can be drawn as under. They will be parallel to each other.
 Characteristics of Iso-cost line

 Iso-cost line is always a straight line.

 The slop of iso-cost line shows the inverse price ratio of two inputs.

 Change in input prices will change the slope of the iso-cost line.

 When the total outlay or budget is increased, the iso-cost line shifts upwards to
the right and it moves farther away from the origin and vice-versa.

 Iso-cost lines are parallel to one other, since relative price ratio remains
constant.
 LEAST COST COMBINATION
 Factor-factor analysis is mainly concerned with the determination of
least cost combination of resources.
 There will be many combinations of two resources that produce the
same level of output.
 The problem here is to find out particular combination of inputs,
which produce a given quantity of output with minimum cost.
There are three methods of finding out least cost combination viz.,
Tabular Method, Algebraic Method and Graphic Method.
 A farmer wants to produce 1000 kg of paddy per acre of land. He has two
types of fertilizers viz., Manures and Urea that can be used to produce the crop.
The following different combinations of Manures and Urea produce the same
quantity of output i.e., 1000 kg of paddy per acre.
Combination Manure (X1) (qty. in cart-load/acre) Urea (X2) (qty. in kg/acre)
A 1 200
B 2 125
C 3 80
D 4 50
E 5 30
F 6 17
G 7 10

Price of Manure is Rs. 200/cart-load and price of Urea is Rs. 5/kg.

Find out least cost combination using all three methods and give your advice to the
farmer about how much quantity of Manure and Urea he should use to produce the
required output.
 Cost of Cost of
Combin Manure (X1) Urea (X2)
X1 (X1*PX1) X2 Total Cost
ation (cart-load/acre) (kg/acre) (X2*PX2)
A 1 200 200 1000 1200
B 2 125 400 625 1025
C 3 80 600 400 1000
D 4 50 800 250 1050
E 5 30 1000 150 1150
F 6 17 1200 85 1285
G 7 10 1400 50 1450

Total Cost of “C” combination is the minimum (least) among all. Therefore, the
farmer should use 3 cart-load of Manure and 80 kg of Urea to produce the given
output.
Algebraic Method
Step-I : Compute the Marginal Rate of Technical Substitution (MRTS)
∆ X2
MRTS X1X2 = ---------
∆ X1
Step-II : Compute the Price Ratio (inverse)
PX1
PR X2X1 = --------
PX2
Step-III : Find out least cost combination by equating MRTS with inverse PR
Combi- X1 X2 ∆X1 ∆X2 MRTSX2X1 PR X1X2
nation (cart-load/ (kg/acre) ∆X1 PX2
acre) = ------ = ------
∆X2 PX1
A 1 200 - - - -
B 2 125 1 75 0.013 0.025
C 3 80 1 45 0.022 0.025
D 4 50 1 30 0.033 0.025
E 5 30 1 20 0.050 0.025
F 6 17 1 13 0.077 0.025
G 7 10 1 7 0.143 0.025

At Combination “C”, MRTS=PR is observed. So, this combination is

the least cost combination. Therefore, the farmer should use 3 cart-load
of Manure and 80 kg of Urea to produce the given output.
 Graphical Method
Step-I : Draw Iso-quant on a graph paper.
Plot X1 (added quantity) on X axis and X2 (replaced quantity) on Y axis to get Iso-quant.
Step-II : Draw Iso-cost Line on the same graph paper.
To draw Iso-cost line we need two extreme points X1 and X2. Suppose, we have a budget of
Rs. 1000. The Maximum quantity of X1 and X2 can be purchased as under:

X1 (cart-load) X2 (kg)
5 0
0 200

Plot these two extreme points of X1 (5,0) and X2 (0,200) on the same graph. Join
these two points X1X2. This line is called Iso-Cost Line.

Step-III : If required, move the Iso-cost line or draw the parallel line in such a way
that it intersects the Iso-quant at one point. This point indicates the least
cost combination of two inputs.
 Iso-cost Line

C
Iso-quant Curve

Conclusion: Combination “C” is found to be least cost because at this level Iso-quant
curve and Iso-cost line intersects to each other. Therefore, the farmer should use 3
cart-load of Manure and 80 kg of Urea to produce the given output
 PRODUCT - PRODUCT RELATIONSHIP
(Law of Product Substitution)

The farmer should choose such a combination of crops and livestock

enterprise that maximizes profit.

 Product-product relationship deals with the allocation of resources among

different crop and livestock enterprise.

 It is explained by the law of product substitution.

 In this relationship, resources or inputs are kept constant and products are
varied.
PRODUCTION FUNCTION USED
Y1 = f (Y2 | X1, X2, …, Xn).
Where, Y1 and Y2 are variable output of two products; X1,
X2, ..., Xn are fixed inputs.
OBJECTIVE
 The objective of product-product relationship is profit maximization.
 The management problem associated with this analysis is what to produce.
 PRODUCTION POSSIBILITY CURVE
 It represents all possible combinations of two products (Y1 and Y2)
that could be produced with given amount of resources.
 It is known as opportunity curve because it represents all the
production opportunities available with a given amount of resources.
It is also called a Production Frontier because the limited resources
cannot help to produce anything beyond production possibility curve. It
demarcates what is possible at a given quantity of inputs.
 Suppose a farmer has a limited input i.e., 5 acres of land. He has two
alternatives i.e., the production of Maize (Y1) crop and/or Bajra (Y2) crop.
Problem here is how to allocate his 5 acres between Y1 and Y2. Here, farmer can
allocate entire 5 acres to Y1 alone or Y2 alone. In between these two extreme
possibilities, he may have different options like, 1 acre to Y1 and 4 acres to Y2 or
2 acres to Y1 and 3 acres to Y2 and so on. For example, different levels of land
and the corresponding levels of output of Y1 and Y2 are as under.

Production (qtl)
Land (acre) Maize (Y1) Bajra (Y2)
1 9 8
2 15 14
3 20 20
4 23 24
5 25 27
 Possible allocation of land among two crops Y1 and Y2 can be done as under.

Allocation of Land in acres Output (Production) in qtls

Combination
Maize (Y1) Bajra (Y2) Maize (Y1) Bajra (Y2)
A 0 5 0 27
B 1 4 9 24
C 2 3 15 20
D 3 2 20 14
E 4 1 23 8
F 5 0 25 0
 Characteristics of Production Possibility Curve

 It is concave to the origin.

 The slope of the curve indicates the marginal rate of product substitution.

 Any combination of Y1 and Y2 inside the curve (Point M) is possible but it reflects
inefficient use of resources.

 Any combination of Y1 and Y2 on the curve (Point A to F) is possible to produce

and it reflects efficient use of resources.

 Any combination of Y1 and Y2 outside the curve (Point N) is not possible to

produce at given amount of resources.

 Change in input levels, shifts the production possibility curve.

 ISO-REVENUE LINE
It is line, which represents all possible combinations of two products
which would yield equal revenue.
Suppose we wish to obtain a total revenue of Rs. 7000. If Price of Y1 is
Rs.1000/q and price of Y2 is Rs.700/q, the expected revenue of Rs.7000 can be
earned by producing 7 quintals of Y1 or 10 quintals of Y2.
Y1 (q) Y2 (q)
7 0
0 10

Plot these two extreme points Y1 (7,0) and Y2 (0,10). Join these two points and
the line that we get is called iso-revenue line (Fig.3). Similarly, the iso-revenue
line for Rs. 4000 and Rs. 9000 can be drawn as under. They will be parallel to
each other
 Characteristics or properties of Iso-revenue Line

 Iso-revenue line is a straight line.

 As the total revenue increases, the iso-revenue shifts upwards and

moves away from the origin and vice-versa.

 The iso-revenue lines are parallel to each other, since price ratio
remains constant,

 The slope of the iso-revenue line indicates the inverse price ratio of
the products. The slop is affected by price change.
 PROFIT MAXIMIZATION
The objective of product-product relationship is to determine which out of all
possible combinations is the most profitable. For this, we require the prices of Y1
and Y2 products. Suppose, the price of Y1 is Rs.1000/q and price of Y2 is
Rs.700/q, for the given example, find out the combination of two crops which
gives the maximum profit.
 Allocation of Production Income
Combi- land (acre) (qtl/acre) Total
nation Income
Y1 Y2 Y1 Y2 Y1*PY1 Y2*PY2

A 0 5 0 27 0 18900 18900
B 1 4 9 24 9000 16800 25800
C 2 3 15 20 15000 14000 29000

D 3 2 20 14 20000 9800 29800

E 4 1 23 8 23000 5600 28600
F 5 0 25 0 25000 0 25000

Combination “D” gives highest Income. Therefore, out of 5 acres, farmer

should grow Y1 crop in 3 acres and Y2 crop in 2 acres of land.
 Algebraic Method
Step 1: Find out Marginal Rate of Product Substitution (MRPS)
Step 2: Find out inverse ‘Price Ratio’ for given prices of Y1 & Y2
Step 3: Compare both MRPS and PR ratio. MRPS=PR gives maximum returns.

Allocation of land Production

Combi- (acre) (qtl/acre) MRPSY PR MRPS PR
∆ Y1 ∆ Y2
nation 1Y2 Y2Y1 Y2Y1 Y1Y2
Y1 Y2 Y1 Y2
A 0 5 0 27 - - - - - -
B 1 4 9 24 9 3 0.33 1.43 3.00 0.70
C 2 3 15 20 6 4 0.66 1.43 1.50 0.70
D 3 2 20 14 5 6 1.20 1.43 0.83 0.70
E 4 1 23 8 3 6 3.00 1.43 0.50 0.70
F 5 0 25 0 2 8 4.00 1.43 0.25 0.70

Combination D represents MRPS=PR. Therefore, out of 5 acres, farmer

should grow Y1 crop in 3 acres and Y2 crop in 2 acres of land.
 Graphical Method
Step 1: Prepare a Production Possibility Curve
Plot Y1 (added quantity) on X axis and Y2 (replaced quantity) on Y axis to get
production possibility curve.

Step 2 : Draw Iso-Revenue Line or Price Line using price data.

To draw iso-revenue line we need two extreme points of Y1 and Y2 which can be
obtained as under:
Suppose, we want to have a total revenue of Rs. 21,000. If Y1 @Rs 1000/q and Y2
@700/q

Y1 (q) Y2 (q)
21 0
0 30
Plot these two extreme points of Y1 (21,0) and Y2(0,30) on the same
graph. Join these two points Y1Y2. This line is called Iso-Revenue Line.
Step 3 : Move Iso-revenue line to intersect production possibility
Curve at one point.
At the point where Production possibility Curve and Iso-
revenue Line intersect is the point of maximum profit. At this
point combination of two products Y1 & Y2 gives maximum
profit.
 Conclusion: The Production Possibility Curve and Iso-revenue Line intersect at D Point.
Thus, combination D represents MRPS=PR. Therefore, out of 5 acres, farmer should grow Y1 crop in 3 acres
and Y2 crop in 2 acres of land.