Farm Management

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Farm Management

• Chapter 8
• Economic Principles ?
• Choosing Input and Output Combinations

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Chapter Outline

• Input Combinations
• Enterprise Combinations

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Input Combinations
Most products require two or more inputs, and the
manager may choose the input combination or ratio
to use. The economic question is whether one
input can be substituted for another to reduce
the cost.
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Types of Input Substitution

• Constant rate (perfect substitution)
• Decreasing rate
• No substitution

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Choosing Inputs

• We will address how to minimize cost for a given
  level of output.
• We will do so by combining isocosts with isoquants

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Producing a GivenOutput at Minimum Cost
Capital per year
Isocost C2 shows quantity Q1 can be produced
with combination K2L2 or K3L3. However, both of
these are higher cost combinations than K1L1.
Labor per year
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Input Substitution When an Input Price Change
Capital per year
Labor per year
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Cost in the Long Run

• Isoquants and Isocosts and the Production
  Function

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Input Substitution Ratio
Input substitution ratio amount of
input replaced amount of input added
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A Firms Expansion Path
Capital per year
150
100
75
50
25
Labor per year
100
150
300
200
50
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A Firms Long-Run Total Cost Curve
Cost per Year
3000
2000
1000
Output, Units/yr
100
300
200
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Figure 8-1Three possible types of substitution
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Input Price Ratio
Input price ratio price of input being added
price of input being replaced
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Decision Rule
input substitution ratio input price ratio If
they cannot be exactly equal because of the
choices available in the table, get as close as
possible without letting the price ratio exceed
the substitution ratio.
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Table 8-1 Selecting a Least-Cost Feed Ration
grain at 4.4 and hay at 3.0
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With Different Types of Substitution

• With a constant rate of substitution, the
  least-cost combination will be all of one input
  and none of the other (unless the price ratio is
  exactly equal to the constant rate of
  substitution).
• With a decreasing rate of substitution, the
  least-cost combination will usually include some
  of each input.

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Enterprise Combinations
Another decision that must be made is the
combination of enterprises to produce to maximize
profits. If one or more inputs is limited, there
is an upper limit on how much can be produced.
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Enterprise Relationships
The first step in determining the profit-maximizin
g combination of enterprises is to determine
the physical relationship among the enterprises.
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Types of Relationships

• Competitive output of one enterprise cannot be
  increased unless output of the other decreases
• Supplementary more output from one enterprise
  can be added without a change in the level of the
  other enterprise
• Complementary as output of one enterprise
  increases, output of the other increases also

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Figure 8-3 Supplementary complementary
enterprise relationships
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Product Transformation Curve
Corn
Soybeans
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Figure 8-2 Production Possibility Curves for
Competitive Enterprises
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Production with TwoOutputs--Economies of Scope

• Observations
• Product transformation curves are negatively
  sloped
• Constant returns exist in this example

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Output Substitution Ratio
Output Substitution Ratio quantity of output
lost quantity of output gained
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Output Price Ratio
Output Price Ratio price of output gained
price of output lost
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Decision Rule
output substitution ratio output price
ratio If no available combination makes
these exactly equal, get as close as
possible without letting the price ratio drop
below the substitution ratio.
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Table 8-2 Profit-Maximizing Enterprise
Combination
corn at 2.80/bu, wheat at 4.00/bu
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Summary
This chapter emphasizes the use of substitution
principles to decide how and what to produce. To
decide how to produce, the manager finds the
least-cost combination of inputs. To decide what
to produce, the manager finds the
profit-maximizing combination of enterprises.