Production Economics
Introduction
• Basic input-output relationships: How do
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we allocate finite resources?
Aquaculture production changes as new
technologies appear
New varieties of inputs as well as
combinations thereof
Nothing is produced with one input!
Production Economics
• Production economics: applying microeconomics to
aquaculture
• Studying production principles should clarify, for the
farmer, issues such as costs, output response to input
and the use of resources to maximize profit/minimize
costs
• REM: production economics is multi-disciplinary
• Must look beyond the biology of production
Production Economics:
Questions to be Answered
• What is efficient production?
• How is the most profitable amount of input
determined?
• How will farm production respond to a change in the
price of an output (fish price)?
• What enterprise combinations will maximize farm
profits?
• How much should farmers pay for a “pump”?
• How will technical change affect output?
Production Economics:
complexity
• Crops grow in seasonal cycles and are affected by
many inputs
• some inputs are controlled by the manager, others
are outside control (e.g., weather)
• these are random events
• time is also important (redfish production cycle
vs. shrimp)
• How do economists deal with these differences?
Economics and Production
Complexity
• Aquaculturists can vary rates of fertilizer, stocking densities, feed, feed
ingredient level, aeration, etc. in ponds
• Response is evaluated in terms of yield
• economists do the same, but with data generated from previous
production cycles, runs, etc.
• Difference: aquaculture research and production lives in the “here and
now”, economists are not “experimental” and use only existing data
• They don’t try to control the inputs. Example: they have no control over
prices, but simply look at what price was in effect when a previous
production cycle occurred
• Bottom line: they manipulate nothing, dependent variable response
already known
Production Theory:
Classification of Inputs
• Those controlled by the manager: variable inputs
• examples: rate of fertilization, feed rate
• fixed inputs: those that don’t change for the
production cycle or length of trial
• examples: harvesting pump; feed silos, vehicles,
land
• random inputs: associated with nature or
economics beyond that of the farm
• remember: growing seasons are unique
Production Theory:
assumptions that make it work
1) Some factors don’t change: 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 bad ex.)
3) perfect certainty: mgr has perfect insight
4) no time discounting* of production (removes time
element from consideration)
5) manager is motivated by profits and is rationally
seeking to optimize them
*Basically, it means that a desired result in the future is perceived as less valuable than one in the present. For
example, if you allow people to choose from being paid an amount in one year as opposed to being paid a smaller
amount now, they will settle for a much smaller payment right now than they will in the future.
Production Theory
Assumptions
• Purpose of assumptions is not to deny the existence of realworld forces on production
• purpose is to simplify the analysis to a point where a
reasonable starting point can be identified
• example: fish farmer deciding, after first 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:
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•
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
input-output 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
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The function can be expressed in many ways:
written form: Y = f(X1, X2, X3,…, Xn)
Y = output or yield
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
Yield
0 lbs
37
139
288
469
667
864
1045
1195
1296
1333
220
1291
Tabular form
Yield (lbs shrimp/ha)
Empirical Example
1400
1200
1000
800
600
TPP curve
400
200
0
0
50
100
150
Lbs of Fertilizer
Graphical form
200
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 in aquaculture; 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
More detail on the Classical
Production Function
1) the production function is a
continuous curve
2) inputs and outputs are perfectly
divisible (otherwise, it would
look like a series of dots)
Yield (lbs shrimp/ha)
Other characteristics of production
function curves:
1400
1200
1000
800
600
400
200
0
0
3) inputs and outputs are
homogenous (prices of product at
one level of input are similar to
others)
50
100
150
200
Lbs of Fertilizer
Total physical product (TPP) Curve
250
Yield (lbs shrimp/ha)
1400
1200
1000
800
600
400
200
0
0
50
100
150
Lbs of Fertilizer
200
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 again…)
• 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 (literature, market evaluations, coffee
shop…)
• 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
Production Assumption 2:
level of technology
• If you produce, it is assumed that you do it via a
certain methodology or process: which method?
• However, we normally assume in production
economics that the manager uses the most up-todate 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
• Problem: few are reported for aquaculture
• The following are general guidelines and
indications useful to farm managers
Three Stages of Production
• 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 production
efficiency
• Production efficiency is not always 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
I
600
II
III
400
200
0
0
50
100
150
Lbs of Fertilizer
APP curve
TPP curve
200
8
7
6
5
4
3
2
1
0
250
Yield (lbs shrimp/ha)
1400
1200
1000
800
I
II
III
600
400
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 4: due next time
1) Develop a production curve using the following data:
Stocking (fry/ac)
Harvest Biomass (lb/ac)
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?