Agri 2312 chapter 6 introduction to production and resource use

transcript

Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward

Reserved.

Introduction toProduction and

Resource Use

Chapter 6

Reserved.

Topics of Discussion

Conditions of perfect competitionClassification of inputsImportant production relationships

(assume one variable input in this chapter)

Assessing short run business costsEconomics of short run decisions

Reserved.

Conditions for Perfect Competition

Homogeneous productsNo barriers to entry or exitLarge number of sellersPerfect information

Reserved.

Classification of Inputs

Land: includes renewable (forests) and non-renewable (minerals) resources

Labor: all owner and hired labor services, excluding management

Capital: manufactured goods such as fuel, chemicals, tractors and buildings

Management: production decisions designed to achieve specific economic goal

Pages 86-87

Reserved.

Production Function

Output = f(labor | capital, land, and management)

Start withone variable

Reserved.

Production Function

Output = f(labor | capital, land, and management)

Start withone variable

assume all other inputsfixed at their currentlevels…

Reserved.

Coordinates of input andoutput on the TPP curve

Reserved.

Total Physical Product (TPP) Curve

Variable inputVariable input

Reserved.

Law of DiminishingMarginal Returns

“As successive units of a variableinput are added to a production process with the other inputs heldconstant, the marginal physicalproduct (MPP) eventually declines”

Reserved.

Other Physical RelationshipsThe following derivations of the TPP curve playAn important role in decision-making:

MarginalPhysical = Output ÷ InputProduct

Reserved.

Other Physical RelationshipsThe following derivations of the TPP curve playAn important role in decision-making:

MarginalPhysical = Output ÷ InputProduct

AveragePhysical = Output ÷ InputProduct

Pages 90-91

Reserved.

Change in output asyou increase inputs

Reserved.

outputoutput

inputinput

Marginal physical product is .45 as labor is increased from 16 to 20

Reserved.

Output per unitinput use

Reserved.

outputoutput

inputinput

Average physical product is .31 if labor use is 26

Reserved.

Plotting the MPP curvePlotting the MPP curve

Change in outputassociated with achange in inputs

Reserved.

Marginal Physcial ProductMarginal Physcial Product

Change from point A to point B on the production function is an MPP of 0.33

Reserved.

Plotting the APP CurvePlotting the APP Curve

Level of outputdivided by the levelof input use

Reserved.

Average Physical ProductAverage Physical Product

Output dividedby labor use is equal to 0.19

Reserved.

Three Stages of ProductionThree Stages of Production

Average physicalproduct (yield) is

increasing in Stage I

Average physicalproduct (yield) is

increasing in Stage I

Reserved.

Marginal physicalproduct falls below the

average physicalproduct in Stage II

Marginal physicalproduct falls below the

average physicalproduct in Stage II

Reserved.

MPP goes negativeas shown on Page 89…

Reserved.

Why are Stage I andStage III irrational?

Reserved.

Productivity rising so why stop???

Output falling

Reserved.

The question therefore is where should I operate in Stage II?

Reserved.

Economic DimensionWe need to account for the price of

the product.We also need to account for the cost

of the inputs.Total Cost of production is the costs

associated with the use of all inputs – Fixed costs

– Variable costs

Reserved.

Key Cost RelationshipsThe following cost derivations play a keyrole in decision-making:

Marginal cost = total cost ÷ output

Reserved.

Averagevariable = total variable cost ÷ output cost

Reserved.

Averagevariable = total variable cost ÷ output cost

Average total = total cost ÷ output cost

Reserved.

From TPP curve onpage 89

Reserved.

Fixed costs are$100 no matter

the level ofproduction

Fixed costs are$100 no matter

the level ofproduction Page 94

Reserved.

Column (2)divided bycolumn (1)

Reserved.

Costs that varywith level of production

Reserved.

Column (4) divided by column (1)

Reserved.

Column (2) plus

column (4)

Column (2) plus

column (4)

Reserved.

Change in column (6) associated with a

change in column (1)

Change in column (6) associated with a

change in column (1)

Reserved.

Column (6) divided by column (1) or

Reserved.

or column (3) pluscolumn (5)

Reserved.

Let’s graph the cost series in this table

Reserved.

Plotted cost relationshipsfrom table 6.3 on page 94

OSDO BE

Plotting costs for levels of outputPlotting costs for levels of output

Reserved.

Marginal and Average Revenue

• Marginal revenue = ∆total revenue ÷ ∆output

Reserved.

Now let’s assume this firm can sell its

product for $45/unit

Reserved.

Key Revenue ConceptsKey Revenue Concepts

Notice the price in column (2) is identical to marginal revenue in column(7). What about average revenue, or AR? What do you see if you divide total revenue in column (3) by output in column (1)? Yes, $45. Thus, P = MR = AR under perfect competition.

Reserved.

Let’s see this in graphical form

Reserved.

Profit maximizinglevel of output,where MR=MC

P=MR=AR $45$45

11.211.2

Reserved.

AverageProfit = $17, or AR – ATC

P=MR=AR

$45-$28$45-$28

$28$28

Reserved.

Grey area representstotal economic profitif the price is $45…

P=MR=AR

11.2 ($45 - $28) = $190.4011.2 ($45 - $28) = $190.40

Reserved.

Zero economic profitif price falls to PBE.Firm would only produceoutput OBE . AR-ATC=0

Zero economic profitif price falls to PBE.Firm would only produceoutput OBE . AR-ATC=0 Page 99

P=MR=AR

Reserved.

Economic lossesif price falls to PSD.Firm would shut downbelow output OSD

Economic lossesif price falls to PSD.Firm would shut downbelow output OSD Page 99

P=MR=AR

Reserved.

Where is the firm’ssupply curve?

P=MR=AR

Reserved.

P=MR=AR

Marginal cost curveabove AVC curve?

Reserved.

Key Revenue ConceptsKey Revenue Concepts

The previous graph indicated that profit is maximized at 11.2units of output, where MR ($45) equals MC ($45). This occursbetween lines G and H on the table above, where at 11.2 unitsof output profit would be $190.40. Let’s do the math….

Reserved.

Doing the math….Produce 11.2 units of output (OMAX on p. 99)Price of product = $45.00Total revenue = 11.2 × $45 = $504.00

Reserved.

Doing the math….Produce 11.2 units of outputPrice of product = $45.00Total revenue = 11.2 × $45 = $504.00

Average total cost at 11.2 units of output = $28Total costs = 11.2 × $28 = $313.60Profit = $504.00 – $313.60 = $190.40

Reserved.

Doing the math….Produce 11.2 units of outputPrice of product = $45.00Total revenue = 11.2 × $45 = $504.00

Average profit = AR – ATC = $45 – $28 = $17Profit = $17 × 11.2 = $190.40

Reserved.

Profit at Price of $45?

Revenue = $45 11.2 = $504.00Total cost = $28 11.2 = $313.60Profit = $504.00 – $313.60 = $190.40

Since P = MR = ARAverage profit = $45 – $28 = $17Profit = $17 11.2 = $190.40

Reserved.

$190.40

Reserved.

Price falls to $28.00….Produce 10.3 units of output (OBE on p. 99)Price of product = $28.00Total revenue = 10.3 × $28 = $288.40

Reserved.

Price falls to $28.00….Produce 10.3 units of output Price of product = $28.00Total revenue = 10.3 × $28 = $288.40

Reserved.

Price falls to $28.00….Produce 10.3 units of outputPrice of product = $28.00Total revenue = 10.3 × $28 = $288.40

Average profit = AR – ATC = $28 – $28 = $0Profit = $0 × 10.3 = $0.00

Reserved.

Q11.210.3

Revenue = $28 10.3 = $288.40Total cost = $28 10.3 = $288.40Profit = $288.40 – $288.40 = $0

Since P = MR = ARAverage profit = $28 – $28 = $0Profit = $0 10.3 = $0 (break even)

Reserved.

Price falls to $18.00….Produce 8.6 units of output (OSD on p. 99)Price of product = $18.00Total revenue = 8.6 × $18 = $154.80

Reserved.

Average total cost at 8.6 units of output = $28Total costs = 8.6 × $28 = $240.80Profit = $154.80 – $240.80 = – $86.00

Reserved.

Average profit = AR – ATC = $18 – $28 = – $10Profit = – $10 × 8.6 = – $86.00

Reserved.

Q11.210.38.6

Since P = MR = ARAverage profit = $18 – $28 = –$10Profit = –$10 8.6 = –$86 (Loss)

Reserved.

Price falls to $10.00….Produce 7.0 units of output (below OSD on p. 99)Price of product = $10.00Total revenue = 7.0 × $10 = $70.00

Reserved.

Average variable costs = $19 Total variable costs = $19 × 7.0 = $133.00 Revenue – variable costs = –$63.00 !!!!!

Reserved.

Q11.210.38.6

Since P = MR = ARAverage profit = $10 – $30 = –$20Profit = –$20 7.0 = –$140

Average variable cost = $19Variable costs = $19 7.0 = $133.00Revenue – variable costs = –$63Not covering variable costs!!!!!!

Since P = MR = ARAverage profit = $10 – $30 = –$20Profit = –$20 7.0 = –$140

Average variable cost = $19Variable costs = $19 7.0 = $133.00Revenue – variable costs = –$63Not covering variable costs!!!!!!

Reserved.

The Firm’s Supply Curve

Q11.210.38.6

Reserved.

Now let’s look at the demand for a single

input: Labor

Reserved.

Key Input RelationshipsThe following input-related derivations also play a key role in decision-making:

Marginal value = marginal physical product × price product

Reserved.

Key Input RelationshipsThe following input-related derivations also play a key role in decision-making:

Marginal value = marginal physical product × price product

Marginal input = wage rate, rental rate, etc. cost

Reserved.

Wage rate representsthe MIC for labor

Reserved.

Use a variable input likelabor up to the point where the value received from the market equals the cost of another unit of input, or MVP=MIC

Reserved.

The area below thegreen lined MVPcurve and above thegreen lined MICcurve representscumulative net benefit.

Reserved.

MVP = MPP × $45MVP = MPP × $45

Reserved.

Profit maximized where MVP = MICor where MVP =$5 and MIC = $5

Reserved.

Marginal net benefit in column (5)is equal to MVP in column (3) minusMIC of labor in column (4)

Reserved.

The cumulative net benefit in column (6) is equal to the sum of successive marginal net benefit in column (5)

Reserved.

For example…$25.10 = $9.85 + $15.25$58.35 = $25.10 + $33.25

Reserved.

Cumulative net benefitis maximized whereMVP=MIC at $5

Reserved.

If you stopped at point E on the MVP curve, for example, you would be foregoing all of the potential profit lying to the right of that point up to where MVP=MIC.

Reserved.

If you went beyond the point where MVP=MIC, you begin incurring losses.

Reserved.

A Final ThoughtOne final relationship needs to be made. The levelof profit-maximizing output (OMAX) in the graph on page 99 where MR = MC corresponds directly withthe variable input level (LMAX) in the graph on page 101 where MVP = MIC.

Going back to the production function on page 88,this means that:

OMAX = f(LMAX | capital, land and management)

Reserved.

In Summary…Features of perfect competitionFactors of production (Land, Labor,

Capital and Management)Key decision rule: Profit maximized at

output MR=MCKey decision rule: Profit maximized

where MVP=MIC

Reserved.

Chapter 7 focuses on the choice of inputs to use and products to produce….

Agri 2312 chapter 6 introduction to production and resource use

Technology