Economics of Production
Introduction
•
Today we will discuss how input-output
relationships are necessary to understanding
problems with resource allocation.
•
Advances in technology change aquaculture
production constantly.
•
No product is produced with a single input
Production Economics
• Economics of production is really microeconomics
applied to aquaculture in our case.
• Studying production principles should clarify issues such
as costs, output response to input, and the use of
resources to maximize profit/minimize costs
• A multi-disciplinary approach is necessary to truly
appreciate production economics.
• Developed from agronomists considering more than the
biology of production
Production Economics: Questions
• What is efficient production?
• How do we determine the most
profitable amount of input?
• How will change in output price influence production?
• How do we maximize farm profits through utilization of
different enterprises?
• How much should you pay for a pump?
• Is technology beneficial to production output?
Production Economics:complexity
• Crops grow seasonally and are affected by
numerous inputs
• Some inputs we control, others are random e.g.,
hurricanes!!)
• Time is also important (e.g. differences in
production cycles)
• Can we cope?
Economics and Production: Complexity
• All the variables you manipulate (i.e. rates of fertilizer, stocking
densities, feed, feed ingredient level, aeration, etc.) affect your
response (yield)
• When we compile multiple years of data from these changes, we can
predict the response in a similar vein to what economist do.
• However, aquaculture research and production lives in the “here and
now”, economists are not “experimental” and use only existing data
• Key difference: economists manipulate nothing. They simply look at
what conditions were in effect when a previous production cycle
occurred.
Production Theory: Classification of Inputs
• Manager has control over variable inputs such as rate
of fertilization, feed rate, etc.
• What we don’t control is called fixed input:, unchanging
during length of trial (harvesting pump; feed silos,
vehicles, land)
• Random inputs: associated with nature or economics
beyond that of the farm
• All this results in unique growing seasons.
Production Theory:
Assumptions that make it work
1)
Factors are continuous for entire production cycle (e.g., level of
technology, land ownership, govt. programs)
2)
Production curve is smooth, well-behaved (e.g., fertilizer, labor is a
bad ex.)
3)
The manager has perfect insight (perfect certainty).
4)
No “time discounting” of production, or discount in price for early
payment of a bill (removes time element from consideration)
5)
Manager is motivated by profits and optimization
Production Theory Assumptions
• Assumpitons are used to simplify the analysis to a
point where a reasonable starting point can be
identified, not to discount real world events.
• Example: following one experiment, to work with a
wider stocking density, over more years
• After the elementary theory has been developed,
each additional source of complexity can be
evaluated
Goals of Production Economics
1) assist farm managers in determining the best use of
resources, given changing needs, values and goals of
society
2) assist policy makers in determining the consequences of
alternative public policies on output, profits, and use of
resources on the farm
3) evaluate the uses of the theory of the firm for improving
farm management and understanding the behavior of the
farm as a profit-maximizing entity
Goals of Production Economics
(continued)
4) evaluate the effects of technical and
institutional changes on aquaculture production
and resource use
5) determine individual farm and aggregated
regional farm adjustments to output supply and
resource use to changes in economic variables
in the economy
How it works:
•
The effect of a single input on output can be
determined if only that input is varied and all
others are held constant.
• Involves:
1) concept of the production function
2) average and marginal physical product
3) various stages of production
Concept of a Production Function
• The production function represents an inputoutput relationship
• describes the rate at which resources are
transformed into products
• relationships vary: animal variety, soil types,
water quality, technologies, El Niño
• any given input-output relationship specifies
the quantities and qualities of resources
needed to produce a particular product
The Production Function
• The function can be expressed in many ways:
written form, tabular, graphical
• written form: Y = f(X1, X2, X3,…, Xn)
• Y = output or yield, the X’s are different inputs
that take part in the production of Y
• examples: yield is a function of stocking
density, feed rate
• Note: this written equation/form does not
specify the importance or contribution of
inputs to the production process
The Production Function
• The production function can also be shown in
either tabular or graphical form
• Usually picks one variable input and studies
the effect on yield
• “Yield” is also referred to as total physical
product or TPP
• Keeps all other variable inputs “fixed” as well
as traditional fixed inputs
• let’s look at an example
Fertilizer
0 lbs/ha
20
40
60
80
100
120
140
160
180
200
220
Tabular form
Yield
0 lbs
37
139
288
469
667
864
1045
1195
1296
1333
1291
Yield (lbs shrimp/ha)
Empirical Example
1400
1200
1000
800
600
400
200
0
0
50
100
150
200
TPP curve
Lbs of Fertilizer
Graphical form
250
Empirical Example
• Data in the previous table/figure represent a production
function relating shrimp yields to applied fertilizer
• units of fertilizer (e.g., nitrogen and phosphate) represent
the variable input, while all other inputs needed to
produce shrimp (seed, labor, fuel, land) are the fixed
inputs
• But hey, I thought fuel, seed, etc. were variable inputs!
Typically, yes, but in this case they remain constant
• As shown, large increases in yield result from initial
fertilizer applications
Empirical Example
• However, yield increases become smaller at higher
levels of application
• A max of 1,330 lbs/ha was achieved with 200 lbs of
fertilizer, afterwards declining
• Zero yield with zero input, in reality, is uncommon;
however, due to infertility of incoming water, soil, etc.
• Note: Although farmers don’t typically use these
functions, as such, they have mental pictures of what
would happen, based on experience
Other characteristics of production
function curves:
1) the production function is a
continuous curve
2) inputs and outputs are
perfectly divisible (otherwise, it
would look like a series of
dots)
3) inputs and outputs are
homogenous (prices of
product at one level of input
are similar to others)
Yield (lbs shrimp/ha)
More detail on the Classical
Production Function
1400
1200
1000
800
600
400
200
0
0
50
100
150
200
Lbs of Fertilizer
Total physical product (TPP) Curve
250
Production Assumptions (1) Perfect
Certainty
• To use the production function,
economists, farmers, etc. must agree upon
the outcome (yield) for each unit of input
• past results (e.g. shrimp yields in response
to fertilizer) must at least approximate this
year’s function (perfect certainty)
• thus, the production function is a planning
device
Perfect Certainty
• Knowing how inputs will perform is difficult year to
year in new industries such as aquaculture
• It helps if you are reasonably sure and on top of
results
• This is one of the big differences between standard
agriculture and aquaculture
• In aquaculture, no two sites are the same – inputs
often function differently from one site to the next
• Reality: care must be given to select the
appropriate production function
• select the right one or suffer the consequences
Production Assumption 2: level of
technology
• If you produce, it is assumed that you do it via a
certain methodology or process
• unfortunately, a product can be produced in many
ways
• we normally assume in production economics that
the manager uses the most up-to-date technology
• Translation: we assume the farmer uses the process
that yields the most output from a given amount of
input
Production Assumption 3: length of
time period
•
•
•
The production function shows output at various
levels of input over a specific length of time
As a result, all inputs (except the one you’re
evaluating ) are fixed
reasons for fixing a variable
1) maybe the amount used is just the right amount,
any more or less would lower profits
2) maybe the production time period is too short to
change the amount of resource on hand (e.g.,
land)
3) the farmer just may not want to change the
amount of resource (e.g., not changing the
number of dairy cattle in order to evaluate a feed
effect)
How to Work with the Production
Function
• There are several classical production functions for
various agricultural situations
• a discussion of all the production functions that now exist
in agriculture would involve more space than any book
could provide
• Problem: few are reported for aquaculture
• it would be impossible to record them all as they happen
• we are simply trying to gain a better understanding of
input-output relations
• the following are general guidelines and indications
useful to farm managers
Three Stages of Production
• The classical production function can be divided
into three stages:
• First Stage: the average rate at which variable
input (X) is transformed into product (Y)
increases until it reaches its maximum (i.e., Y/X
is at its maximum)
• this maximum indicates the end of Stage 1
Production Stage 1
• Stage 1 deals with increasing bang for your buck or
the phase of increasing production efficiency
• production efficiency is not just the maximum
production level
• This efficiency is known as average physical
product, APP and is determined by dividing yield by
its corresponding amount of input (Y/X)
• Stage 1 ends where Y/X is largest, around 150 lbs
input
Production Efficiency
Input (X)
0
20
40
60
80
100
120
140
160
180
200
220
Output (Y)
0
37
139
288
469
667
864
1045
1195
1296
1333
1291
APP (X/Y)
1.9
3.5
4.8
5.9
6.7
7.2
7.5
7.5
7.2
6.7
5.9
• Stage 2: physical efficiency
of the variable input is at a
peak at the beginning of
Stage 2
• Stage 2 ends when yield
(APP) is at its maximum
• Bottom line: maximum
efficiciency does not equal
maximum production
Yield (lbs shrimp/ha)
Three Stages of Production
1400
1200
1000
800
600
I
400
II
III
200
0
0
50
100
150
Lbs of Fertilizer
APP curve
TPP curve
200
8
7
6
5
4
3
2
1
0
250
Three Stages of Production
• Stage 3: starts once TPP starts to decline
• result of excessive quantities of variable input
combined with fixed inputs
• in order for all this to make sense, we need to
understand that production functions are used to
determine the most profitable amount of variable
input and output
• the production function allows you to make
recommendations about input use even when
input/output prices are unknown
What this Describes: Law of
Diminishing Returns
• Originally developed by early economists to describe
the relationship between output and a variable input,
when other inputs are constant
• if increasing the amount of one input is added to a
production process while all others are constant,
additional output will eventually decrease
• implies there is a “right” level of variable input to use
with the combination of fixed inputs
Law of Diminishing Returns
• Requires that the method of production does
not change as variable input changes
• does not apply when all inputs are varied
• when the LDR is applied to production you
get the classical production function
• increasing marginal returns at first and
decreasing marginal returns afterwards
• it is possible that marginal returns could
decrease in the beginning with the first
application of the variable input
Economic Recommendations
• 1) using logic you can see that if your production follows that of
the example given, you should increase inputs to achieve a
production level at least until Stage 2 is reached;
• it doesn’t make sense to stop increasing input if its efficiency is
increasing
• 2) even if inputs are free, you don’t want to be in Stage 3;
• the largest amount of input you would use is that at the end of
Stage 2
• the area of economic relevance is within Stage 2 for firms that
buy and sell in competitive markets
• fine tuning comes from knowing prices
Homework 3: due next time
1) Develop a production curve using the following data:
Stocking (fry/ac)
Harvest Biomass (lb/ha)
0
0
1,000
185
2,000
695
3,000
1,440
4,000
2,345
5,000
3,335
6,000
4,320
7,000
5,225
8,000
5,975
9,000
6,480
10,000
6,665
11,000
6455
2) At what level of input would Stage 2 start?
Next Time: Supply and
Demand Relationships
(Seperich et al., 1994)