AAEC 2305
Fundamentals of Ag Economics
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Chapter 6 - Continued
 Maximization: Input Basis
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• Objective is to determine level of input
use that will maximize .
• Achieved by comparing value of output
produced to value of inputs used.
• Product curves from ch. 2 show
relationship between input use and
physical pdn – by multiplying each
product curve by Py – pdn measured on
an output basis can be translated to pdn
measured on a value (monetary) basis –
we can now show relationship between
input use and value of pdn.
Revenue Product Curves
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• Total Revenue Product (TRP) – Dollar
value of output produced from
alternative levels of variable input.
– Also called Total Value Product (TVP)
– TRP = TPP * Py
Revenue Product Curves
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• Average Revenue Product (ARP) –
average value of output per-unit of input
at each input level
– Also called Average Variable Product
(AVP)
– ARP = APP * Py
Revenue Product Curves
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• Marginal Revenue Product (MRP) –
additional (marginal) value of output
obtained from each additional unit of
variable input
– Also called Marginal Value Product
(MVP) or Value of Marginal Product
(VMP)
– MRP = ΔTRP / ΔX = MPP*Py
• Diagram Revenue Product Curves
Marginal Factor Cost (MFC)
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• MFC – cost of an additional unit of input
or amount added to total cost from using
one more unit of variable input (Px)
– Because the firm is assumed to be a
price taker and Px is fixed – MFC is
graphed as a horizontal line
Marginal Factor Cost
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• NOTE: MFC  MC
– MC is calculated on the basis of a
change in output - (change in total cost
divided by the change in output)
– MFC is calculated on the basis of a
change in input use and is always Px –
(change in total cost divided by the
change in input use)
Economic Rule
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• Producer determines how much input to
use by comparing the value of output
produced by each input level to the cost
of using that input level.
• ** Producer should continue to use
additional units of input until the
additional value of output received from
using an additional unit of input is equal
to (or slightly larger than) the cost of
using that unit of input – or comparing
MRP to MFC such that MRP  MFC
Continued
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• If the additional value of output received
from using an additional unit of input is
less than the cost of that input, the firm
will not use that unit of input
Firm’s Demand Curve for
Variable Input
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• The MRP curve provides us with
information of how much of an input will
be utilized or demanded at various prices
for that input – this is referred to as
Factor Demand.
• The demand for an input reflects the
value that input adds to revenue, or its
MRP.
Firm’s Demand Curve for
Variable Input
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• As the price of an input changes, the
quantity of input used (or demanded) by
the firm also changes
• Hence, using ’s in input price level &
the decision rule MRP  MFC, we can
trace the firm's demand schedule for that
input holding all other inputs and their
prices constant
Position of Firm’s Demand
Curves for Variable Input
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• Since MRP = MPP * Py, the position of
the firm’s factor demand curve depends
on both Py and the underlying pdn
function.
• Therefore, a  in either TPP or Py will
cause the MRP curve to shift.
Production of Multiple Outputs
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• If a firm is producing two products –
How does it decide how much of each to
produce?
• The decision depends on the degree of:
1) Supplementarity
2) Complementarity
3) Competition
between the two goods.
Production Possibilities Frontier
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• Production Possibilities Frontier (PPF) –
a curve depicting the maximum amount
of various combinations of two products
that can be produced using a given (or
fixed) level of inputs.
• Marginal Rate of Product Substitution
(MRPS) – measures the slope of the PPF
• MRPS describes the rate at which one
output must be decreased as production
of the other product is increased.
• MRPS = Δ Y1 / Δ Y2
(continued)
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• The curve is called a frontier because it
shows the maximum that can be
produced.
• The curve of the PPF is the result of the
law of diminishing marginal returns.
• The shape of the curve indicates that the
goods are substitutes in production,
which means they compete for resources
in production.
Possible PPF Relationships
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• Competition – occurs when increasing
the output of one product reduces the
output of the other.
• Complementary – occurs when
increasing the output of one product
increases the output of the other.
• Supplementary – occurs when the two
products use different resources or the
same resources at different times.
Isorevenue Line
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• Isorevenue line – a line depicting all
combinations of two products that will
generate a given (or same) level of total
revenue.
– Slope of the Isorevenue line is equal to the
negative inverse of the price ratios.
Production of Multiple Outputs
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• The firm maximizes profit by operating
where the isorevenue line is tangent to
the PPF.
• Therefore, the profit-maximizing output
levels occur where the slope of the PPF
equals the slope of the isorevenue line.