Stages of production.pptx

AGRB 3020: Economics of Farm Management Lessons from Microeconomics (Economics of Farm Management in a Global Setting Chapter 4) Spring Review: Discuss the differences between cash and accrual accounting Cash: No transactions are recorded unless cash is spent or received Accrual: Records as revenue...

AGRB 3020: Economics of Farm Management Lessons from Microeconomics (Economics of Farm Management in a Global Setting Chapter 4) Spring Review: Discuss the differences between cash and accrual accounting Cash: No transactions are recorded unless cash is spent or received Accrual: Records as revenue the value of all products produced and all services provided during a year AGRB 3020:Econ. Of Farm Management 2 Total Revenue, Total Cost, Profit Profit = Total revenue – Total cost the amount a farm receives from the sale of its output the market value of the inputs a farm uses in production Costs: Explicit vs. Implicit Explicit costs – require an outlay of money, e.g. paying wages to workers Implicit costs – do not require a cash outlay, e.g. the opportunity cost of the owner’s time Economic Profit vs. Accounting Profit Accounting profit = total revenue minus total explicit costs Economic profit = total revenue minus total costs (including explicit and implicit costs) Accounting profit ignores implicit costs Quotes: Dwight D. Eisenhower: “Farming looks mighty easy when your plow is a pencil, and you are a thousand miles from the corn field” Marty Allen: “A study of economics usually reveals that the best time to buy anything is last year” AGRB 3020:Econ. Of Farm Management 6 Agenda: Review of basic microeconomic concepts AGRB 3020:Econ. Of Farm Management 7 Some Definitions Microeconomics The study of the behavior of individuals (persons, businesses etc.) and of the markets they participate in Macroeconomics The study of national and international economies and of the trade between nations AGRB 3020:Econ. Of Farm Management 8 Time for an auction  http://www.youtube.com/watch?v=ZnNG074CtJ4 In both an auction and a retail store setting the number of items sold and bought depend on the price AGRB 3020:Econ. Of Farm Management 9 Basic Economic Principles When should we increase the use of an input? If the value of the added output is greater than the added cost AGRB 3020:Econ. Of Farm Management 10 Basic Economic Principles When should we substitute one input for another? If the cost of the substituted input is less than the cost of the replaced input and the production level is maintained AGRB 3020:Econ. Of Farm Management 11 Basic Economic Principles Since resources are limited we should:  Use each unit of resource where it will give the greatest return When choices involve time periods  Compare based on present values AGRB 3020:Econ. Of Farm Management 12 Review of some definitions Fixed Costs Those that occur no matter what or how much is produced on a farm Variable costs Directly associated with the volume of business. Vary in total with the size of the business Variable In the long run all costs are ____________ AGRB 3020:Econ. Of Farm Management 13 More Definitions Direct Costs Used directly in the production process (i.e. seeds) Overhead costs Hard to assign to a particular enterprise AGRB 3020:Econ. Of Farm Management 14 Some Definitions Average Product Total product divided by the units of input used AGRB 3020:Econ. Of Farm Management 15 Marginal Concepts What does marginal means? Incremental change, additional, extra Provide some examples of marginal concepts Marginal cost, Marginal Product, Marginal Revenue will be used to make decisions AGRB 3020:Econ. Of Farm Management 16 How to calculate marginal values Find the difference (Δ) between an original value and a new value which resulted from the change in the control factor AGRB 3020:Econ. Of Farm Management 17 Marginal Product The marginal product of any input is the increase in output arising from an additional unit of that input, holding all other inputs constant. E.g., if Farmer Jack hires one more worker, his output rises by the marginal product of labor. Notation: ∆ (delta) = “change in…” Examples: ∆Q ∆Q = change in output, ∆L = ∆L change in labor Marginal product of labor (MPL) = EXAMPLE 1: Total & Marginal Product L Q (no. of (bushels workers) of wheat) ∆L = 1 ∆L = 1 ∆L = 1 ∆L = 1 ∆L = 1 0 0 1 1000 2 1800 3 2400 4 2800 5 3000 MPL ∆Q = 1000 1000 ∆Q = 800 800 ∆Q = 600 600 ∆Q = 400 400 ∆Q = 200 200 Example: Input Level TP AP MP 0 10 NA NA 1 15 15 5 2 32 16 17 3 13 4 39 44 11 7 5 5 40 8 -4 AGRB 3020:Econ. Of Farm Management 20 What is a Production Function A systematic way of showing the relation between the resources used to produce a product and the corresponding output of that product. AGRB 3020:Econ. Of Farm Management 21 Law of Diminishing Marginal Returns As one factor of production is increased while all other factors remain constant the returns from additional levels of the first factor will decrease. AGRB 3020:Econ. Of Farm Management 22 Important Assumptions For diminishing returns to exist we must have one or more fixed inputs Diminishing returns can exist with the first unit of variable input AGRB 3020:Econ. Of Farm Management 23 Graphically AGRB 3020:Econ. Of Farm Management 24 Stages and Relationships AGRB 3020:Econ. Of Farm Management 25 Total Cost - Total Income Totals are interesting as a measure but they are not very useful in business analysis. For example, we can not tell if the cost is too high or too small unless we specify the size of our farm, the crops, the type of soil etc. AGRB 3020:Econ. Of Farm Management 26 Average Cost – Average Income  Cost per acre is useful in analyzing the efficiency of the use of these items.  Average income (income per unit of production) is useful because we can directly compare it with the price. AGRB 3020:Econ. Of Farm Management 27 Marginal Cost – Marginal Income Marginal cost: The additional cost of obtaining the additional production Marginal revenue is the value of the additional production Marginal input cost: The cost of using an additional unit of a specific input AGRB 3020:Econ. Of Farm Management 28 How much input to use Compare Marginal Input cost to Marginal Value Product MVP = MIC This is not!! The maximum yield point It is an equality not an equation ! In the next example assume price =2 AGRB 3020:Econ. Of Farm Management 29 Example: AGRB 3020:Econ. Of Farm Management 2 0 3 0 3 0 3 2 2 2 1 3 0 1 4 4 30 Short-run analysis of Total, Average, and Marginal product The Three Stages of Production in the short run: Stage I: from zero units of the variable input to where AP is maximized (where MP=AP) Stage II: from the maximum AP to where MP=0 Stage III: from where MP=0 on 31 Identify the three stages of returns # of Workers Total Product(TP) (Input) 0 1 2 3 4 5 6 7 8 0 10 25 45 60 70 75 75 70 Marginal Product(MP) Average Product(AP) - - 10 10 15 12.5 20 15 15 15 10 14 5 12.5 0 10.71 -5 8.75 32 Identify the three stages of returns # of Workers Total Product(TP) PIZZAS (Input) 0 0 1 10 2 25 3 45 4 60 5 70 6 75 7 75 8 70 Marginal Product(MP) 10 15 20 15 10 5 0 -5 Average Product(AP) 10 12.5 15 15 14 12.5 10.71 8.75 33 How much input to use Compare Marginal Input cost to Marginal Value Product MVP = MIC This is not!! The maximum yield point It is an equality not an equation ! AGRB 3020:Econ. Of Farm Management 34 P(output)= $2, Example: P(input)= $14 AGRB 3020:Econ. Of Farm Management 2 0 3 0 3 0 3 2 2 2 1 0 3 4 1 4 35 Example: P(output)= $2, P(input)= $14 AGRB 3020:Econ. Of Farm Management 1 1 4 1 4 2 1 4 8 4 1 1 4 4 2 1 0 6 36 Example:P(input)= $14.1 AGRB 3020:Econ. Of Farm Management 37 P(input)= $13.99 Example: AGRB 3020:Econ. Of Farm Management 38 Equal Marginal Principle  MVP = MIC assumes sufficient input is available or can be purchased What about limited inputs (i.e. capital) and many potential uses ? AGRB 3020:Econ. Of Farm Management 39 Equal Marginal Principle A limited input should be allocated among alternative uses in such a way that the marginal value products of the last unit used on each alternative are equal If we can not achieve equality then the MVP of the last unit allocated should always be equal or greater than the MVP available from any other alternative use AGRB 3020:Econ. Of Farm Management 40 Example AGRB 3020:Econ. Of Farm Management 41 Question #2:  How Much Output to produce? If you know how much input to use, then you can look at the production function and find the corresponding output. There is another way, however, to get the same point. This time we will approach the profit maximizing point from the output perspective AGRB 3020:Econ. Of Farm Management 42 Decision #2:  MR = MC An equality not an equation If they are not equal then MR > MC AGRB 3020:Econ. Of Farm Management 43 How to calculate: MR = ΔTR/Δoutput MC = ΔCost/ΔOutput Δoutput = Marginal Product AGRB 3020:Econ. Of Farm Management 44 EXAMPLE 1: Total and Marginal Cost Q (bushels of wheat) ∆Q = 1000 ∆Q = 800 ∆Q = 600 ∆Q = 400 ∆Q = 200 0 1000 1800 Total Cost $1,000 $3,000 $5,000 2400 $7,000 2800 $9,000 3000 $11,000 Marginal Cost (MC) ∆TC = $2000 ∆TC = $2000 ∆TC = $2000 ∆TC = $2000 ∆TC = $2000 $2.00 $2.50 $3.33 $5.00 $10.00 Why MC Is Important ? Farmer Jack is rational and wants to maximize his profit. To increase profit, should he produce more wheat, or less? To find the answer, Farmer Jack needs to “think at the margin.” If the cost of additional wheat (MC) is less than the revenue he would get from selling it, then Jack’s profits rise if he produces more. (In the next chapter, we will learn more about Decision #2: AGRB 3020:Econ. Of Farm Management 47 Example:P(output)= $10, P(input)=$2 1 0 2 0 AGRB 3020:Econ. Of Farm Management 1 0 1 3 2 2 5 8 8 6 48