Cost

1
Cost Return Analysis

• Farm Ranch Business Management
• Chapter 5

2
Production Function

• As inputs are changed, outputs are changed also
• Example fertilizing wheat

3
Where is the maximum profit?

• Lbs. Of Fertilizer Yield
• 0 20
• 20 25
• 40 32
• 60 40
• 80 45
• 100 48
• 120 45

4
Law 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
• English Translation if you were to increase the
  amount of fertilizer on wheat, your yield in
  bu./acre would increase dramatically for the
  first few units, until you added enough
  fertilizer that the rate of yield increase would
  slow down, and may even become negative

5
Law of Diminishing Returns

• Lbs. Of Fertilizer Yield Added
• 0 20 0
• 20 25 5
• 40 32 7
• 60 40 8
• 80 45 5
• 100 48 3
• 120 45 -3

6
Stages of the Production Function

• Stage 1 increasing average return for each
  added unit of input
• Average Product Total Yield divided by number
  of units added

7
Stage 1 Example

• Lbs. Of Fert. Yield Added Avg Prod.
• 0 20 0 20
• 20 25 5 25
• 40 32 7 16
• 60 40 8 13.3
• 80 45 5 11.1
• 100 48 3 9.2
• 120 45 -3 7.5

8
Stages of the Production Function

• Stage 2 begins when the marginal product equals
  the average product.
• Diminishing returns begin to develop in stage 2
• Stage 3 begins when the marginal product
  becomes 0.
• Total product decreases if input is increased

9
Stage 3 of the Production Function

• Lbs. Of Fert. Yield Added Avg Prod.
• 0 20 0 20
• 20 25 5 25
• 40 32 7 16
• 60 40 8 13.3
• 80 45 5 11.1
• 100 48 3 9.2
• 120 45 -3 7.5

10
How much fertilizer?

• Lbs. Of Fert. Yield Added Avg Prod.
• 0 20 0 20
• 20 25 5 25
• 40 32 7 16
• 60 40 8 13.3
• 80 45 5 11.1
• 100 48 3 9.2
• 120 45 -3 7.5

11
Profit Maximizing Rule

• Add the variable input (fertilizer) to the point
  where the value of the marginal product equals
  the value of the added input.

12
Profit Maximizing Rule

• Fert. Total Yield
• Lbs. Cost Yield Added Val.Add Avg Prod.
• 0 20 0 20
• 20 10 25 5 15 25
• 40 10 32 7 21 16
• 60 10 40 8 24 13.3
• 80 10 45 5 15 11.1
• 100 10 48 3 9 9.2
• 120 10 45 -3 -9 7.5

13
Profit Maximizing Rule

• Fert. Total Yield
• Lbs. Cost Yield Added Val.Add Avg Prod.
• 0 20 0 20
• 20 15 25 5 12.50 25
• 40 15 32 7 17.50 16
• 60 15 40 8 20 13.3
• 80 15 45 5 12.50 11.1
• 100 15 48 3 7.50 9.2
• 120 15 45 -3 -7.50 7.5

14
Fixed Costs

• Not used in profit maximizing rule
• Must be considered to determine if you will make
  a profit or not

15
Opportunity Cost

• Cost of using a resource in one way based on the
  return that could be obtained from using the
  resource in another way
• Ex labor, what is your labor worth if not
  farming?
• Ex interest, your money could sit in a bank and
  earn interest, or be used to invest in your
  business (farm)

16
Least Cost Mathematical Approach

• If one input (soybean meal) can be substituted
  for another (corn)
• Usually dont substitute at equal rates
• Change in corn Price of SBM
• Change in SBM Price of Corn
• Corn .05 and SBM .13, ratio .13/.05 2.6
• Now divide changes and find a ratio of 2.6
• Page 5-11

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