Cost & Return AnalysisAg Management

Ch 5

Objectives

Describe inputs and outputs Explain the principle of diminishing returns Describe the 3 stages of the production

function Describe the amount of inputs that will return

the maximum profit Determine the opportunity cost

Input-Output Relationships

Inputs

Materials that determine fixed and variable costs

Outputs

The different results of varying the amount of input used in production

Relationship of Inputs & Outputs

The basic relationship that allows analysis of an input and an output is called a production function

See Example p. 5-2 to 5-4

Principle of Diminishing Returns

As an input is added in production, the output will increase at an increasing rate then at a decreasing rate and finally decline

Fig 1 p. 5-4

3 Ways of Measuring Production

Total Product (TP)› The production (output) that can be achieved with the

various levels of input.› Example: We apply one unit of fertilizer and we get an

amount of output, when plotted this gives the TP curve.

Average Product (AP)› Total Product/Amount of Input

Marginal Product (MP)› Change in total product for a change in input

Examples- Table 2 Columns 1-4 p. 5-5

3 Stages of Production Function

1. An increasing average return for each added unit of input.

› Average product (AP)= Total Yield (TP)/ the Number of Units of the Variable Input

2. Begins when Marginal Product (MP)=Average Product (AP)

› Diminishing returns begin to develop in Stage 2

3. Begins when Marginal Product (MP) becomes 0.› In this stage the total product actually decreases if

the input increases.

Profit Maximizing Rule

Maximum profit will be obtained if you add the variable input to the point where the value of the marginal product (VMP) equals the price of the added input

VMP=Price of Input VMP is found by multiplying Marginal

Product (MP) by the price of the product› MP x Price of Product= VMP

Opportunity Costs

The cost of using a resource one way based on the return that could be obtained from using it in the best alternative way.

Example: p. 5-6

Input-Input Relationship

Why Input-Input Relationships are Used

Inputs have individual and combined impacts on the final product

Methods of Determining Least Cost Ration Formula

Graphics Mathematical p. 5-9

“Same Production” Line

Used in the graphical least cost ration method

Occurs when all points are connected into a line segment

Fig 4 p. 5-9—the line shows the combination of soybean oil meal and corn for 100 pounds of gain for 60 lb hogs

“Same Cost” Line

Take a given amount of money and divide by the cost per pound of a feedstuff to get the quantity of feed that amount of money will purchase. Do the same for other feedstuffs, connect points A and B and this is the same cost line

See p. 5-9 , 5-10 (fig 6)

Least Cost Ration

Found by moving the same cost line parallel to itself until it touches the same production line at one point only.

Point C fig 6 p. 5-10 Mathematical Formula

Change in Feed A/Change in Feed B= Price of Feed B/Price of Feed A

Math Method Steps

1. Determine the rate that one input substitutes for another. This is the marginal rate of substitution.

2. Compute the price ration. This should be the price at the point of use.

3. Find the ration for which the two rations are equal. This is the least-cost combination of the two inputs.

Break-Even Analysis

Can provide price and/or yield targets that can be beneficial in planning

Risk Management Analysis

When used in enterprise budgets can be useful when completing the financial analysis

Table 3/Table C---Crop Insurance

Summary & Assignment*

Summary p. 5-12 Assignment complete review questions 1-9.