Production II

Farm and Ranch Management
o Decision-making process whereby limited resources are allocated to a
number of production alternatives to obtain some objective

Types of problems faced
o How much to produce? How to produce? What to produce?

Three primary functions of management
o Planning, implementation, and control

Marginal
o Refers to incremental changes, increases or decreases, which occur at edge

Planning
o Primarily making choices, but also organizing

Production Function
o Systematic way of showing the relationship between different amounts of
a resource or input that can be used to produce a product and the
corresponding output, also call response curve, yield curve, or input/output
curve

TPP
o Total physical product, output or yield

APP
o Average physical product, average amount of output produced by each
unit of input, TPP/input level

MPP
o Marginal physical product, the additional TPP produced by using an extra
unit of input, change in TPP divided by change in input level, also
derivative

Stages of Production
o Classic 3 stage production function
o Stage one- TPP increasing at an increasing rate, APP increasing, MPP
increasing and decreasing
o Boundary Stage 1 and Stage 2, MPP = APP, APP is at its maximum
o Stage 2- TPP increasing at decreasing rate, APP and MPP decreasing,
logical stage of production
o Boundary Stage 2 and Stage 3- MPP= zero, TPP is at its maximum
o Stage 3 – TPP and APP decreasing, MPP is negative

Law of diminishing returns
o As additional units of a variable input are used in combination with one or
more fixed inputs, the marginal physical product will eventually begin to
decline

TVP
o Total value product, the quantity of output (TPP) multiplied by the selling
price, same as gross income

MVP
o Marginal value product, the additional revenue received from using an
additional unit of input, MVP = change inTVP divided by change in input
level

AVP
o Average value product, average gross revenue per unit of input used,
TVP/input level

MIC
o Marginal input cost, change in total input cost or the addition to total input
cost caused by using an additional unit of input, MIC – change in total
input cost/ change in input level

Profit maximizing point
o where MVP = MIC

MR
o Marginal revenue, the additional income received from producing another
until of output, MR = change in total revenue/ change in total physical
product

MC
o Marginal cost, the additional cost incurred from producing another unit of
output, MC = change in total input cost/ change in total physical product
o MR + MC
o Output level where profits will be maximized
o Input substitution ratio
o Amount of input A replaced divided by amount of input B added, the rate
at which one input will substitute for another
o Constant rate of substitution
o The input substitution ratio is constant over the full range of possible input
combinations

Decreasing rate of substitution
o as more of one input is substituted for another, it becomes increasingly
difficult to make the substitution and still maintain the same level of
output

Price ratio for inputs
o Price of input A divided by price of input B

Least-cost combination of inputs
o The substitution ratio and price ratio are equal

Production Possibility Curve
o PPC, shows all possible combinations of two outputs that can be produced
from a given fixed input

Substitution ratio between products
o Quantity of output lost divided by quantity of output gained

Where is profit maximized?
o Where substitution ratio between products is equal to the price ratio for the
products, price ratio is the unit of output being gained divided by the unit
price of the output being lost, opposite of the substitution ratio

Enterprise relationships
o Competitive- given a limited input output of one enterprise can only be
increased if the output of the other is decreased
o Supplementary- the production form one enterprise can be increased
without affecting the production level of the other
o Complementary- increasing the production level of one enterprise causes
the production of the other enterprise to increase

Equal marginal principle
o A limited input should be allocated among alternative uses in such a way
that the marginal value products of the last unit are equal in all uses

What is required to maximize profits from the total business?
o The proper allocation of limited inputs, which will not necessarily result in
maximizing the profit from any single enterprise

Opportunity cost
o The value of the next best alternative

Cost concepts
o TFC-total fixed costs
o AFC- average fixed costs
o TVC- total variable costs
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AVC-average variable costs
TC- total costs
ATC- average total costs
MC- marginal costs
Short Run- at least one fixed input level
Long Run- all inputs are variable
Fixed costs- incurred if no production
Variable costs- costs associated with the level of production

DIRTI 5
o Fixed costs, depreciation, insurance, repairs, taxes (property), and interest

Any elasticity
o % change of one item divided by % change of some other item

Cost curve relationships
o Total Cost Curves
 Fixed- constant and unaffected by output level, horizontal line
 Variable- always increasing first at a decreasing rate then at an
increasing rate
 Total- sum of fixed and variable, always higher than variable by a
vertical distance
 Fixed costs- same shape as variable costs curve
o Averages and Marginal Cost curves
 Average fixed Cost- always declining but at a decreasing rate
 Average Variable Cost- U shaped
 Average Total Cost- U shaped, average variable and total cost
curves approach each other as output decreases
 Marginal Cost- generally increasing, crosses average cost
curves at their minimum values

Economies of Size
o Increasing returns to size, exists when the long run average cost curve is
decreasing ,LRAC is decreasing

Constant returns to size
o LRAC is constant

Decreasing returns to size
o Increasing LRAC

Principle of Comparative Advantage
o States that individuals or regions will tend to specialize in the production
of those commodities for which their resources give them a relative or
comparative advantage, it is relative not absolute yields, costs and profits
are importuning in this principle

Enterprise Budget
o A listing of all estimated income and expenses associated with a specific
crop or livestock commodity to provide an estimate of its profitability

What does an enterprise budget represent?
o Any enterprise budget represents only one point on the production
function, not the max. pt. changing component changes the profit
associated with the enterprise

Break Even Analysis:
o Break-even yield = total costs/ output price
o Break-even price = total costs/ expected yield

Cost of production
o The average cost of producing one unit of a given product

Partial budgets
o Used to calculate expected change in profit for a proposed change in the
farm business, differs from an enterprise in that several enterprises might
be involved in the change, contains only those income and expenses which
will change because of the proposed modification or change

Whole farm Budget
o Involves plans for the entire operation, detailed physical and financial plan
for the organization and operation of the total business, summary of the
expected income, expenses, and profits

Gross margin
o Income above variable cost for an enterprise

Linear programming
o Mathematical technique to solve a problem with linear objective function,
linear constraints, and alternative ways to produce

Cash Flow Budget
o A summary of cash inflows and outflows for a business over a given
period of time
Balance Statement
o Summarizes the financial condition of the business at a point in time


Income Statement
o Summarizes the financial condition of the business at a point in time

Depreciation
o Noncost expense, accounting procedure to spread the original cost of an
item over its useful life

Depreciation Methods
o Straight line, double declining balance, modified accelerated cost recovery
system (MACRS), sum of the year’s digits

Ratio analysis
o See finance review

Forms of business organization
o Sole proprietorship, partnerships, corporations

Capital and use of credit
o See finance review

Principle of increasing risk (use of credit)
o As the debt/equity ratio leverage increases, the borrower has a greater risk
of losing equity capital


See acronyms for government agencies associated with farm management
Cost of borrowing
o Interest rate paid, interest is tax deductible, principle payment is not

Investment analysis
o Time value of money, see finance review

Cash vs. Accrual methods
o See finance review

Tax basis & capital gains
o See finance review

Short-run situations
o Expected selling price > ATC, a profit can be made and is maximized by
producing where MR = MC
o Expected price < ATC but > AVC, a loss is expected, but the loss will be
less than total fixed cost and is minimized by producing at the point MR =
MC
o Expected Price < AVC, minimize loss by not producing, loss will equal
TFC