Chapter 3: Economics for Agribusiness Managers

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Chapter 3 Economics for Agribusiness
Managers
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Definition of Economics

• The study of how scarce resources are combined to
  meet the needs of people in a society of
  unlimited wants.

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Scarce Resources

• Factors of production
• Land
• Labor
• Capital
• Management

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The US A Market-Oriented Capitalistic Economy

• Market-oriented
• Consumers make wants known by voting with
  their dollars
• Producers respond by adjusting production and
  products offered

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Capitalism

• A system in which property is owned and
  controlled by private citizens.
• Any profits generated by the use of the property
  belongs to the owner.

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Why Profits Exist in Our Economy

1. Profits are the reward for taking a risk in
   business
2. Profits result from the control of scarce
   resources
3. Profits exist because not all information is
   widespread
4. Profits occur when a business is managed better
   than others

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Macroeconomics The Big Picture

• Macroeconomics is concerned with how the
  different elements of the total economy interact
• Examples that impact agribusinesses
• Monetary policy
• Fiscal policy
• International development

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Microeconomics Economics Within the Firm

• Microeconomics is the application of basic
  economic principles to decisions within the firm
• Example of microeconomic decisions
• How to best use physical, human, and financial
  resources to meet customers needs and generate a
  profit

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Opportunity Cost

• The income given up by not choosing the next
  best alternative for the use of the resources
• Opportunity costs are never actually incurred
  and cannot be measured precisely

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Economic Profit

• Economic profit equals accounting profit less
  opportunity cost
• Calculating economic profit requires examining
  alternative uses of resources

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Example Determining Economic Profit

• Situation
• Susan Lambert owns/operates a landscaping firm
• She wants to determine her economic return for
  operating this firm
• Susan is 30 years old
• She has 400,000 invested in the business
• She makes a salary of 35,000
• The business made 75,000 profit last year

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Example Determining Economic Profit

• Susans accounting profit
• Net income of business 75,000
• Salary withdrawal 35,000
• Total accounting profit 110,000

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Example Determining Economic Profit

• Alternative uses for Susans economic resources
• Sell business, work for someone else making
  30,000 annually
• Reinvest 400,000 investment in savings account
  (5), government bonds (6), corporate bonds
  (8)

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Example Determining Economic Profit

• Opportunity cost
• Other job 30,000
• Best investment alternative 400,000 x
  0.08 32,000
• Total opportunity cost 62,000

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Example Determining Economic Profit

• Total accounting profit 110,000
• - Total opportunity cost 62,000
• Economic profit 48,000

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Demand The Buyer Side of the Market

• Demand the quantity that buyers are willing and
  able to buy in the market at various prices

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Figure 3-4 Demand Curve
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Law of Diminishing Marginal Utility

• As more and more of a product is consumed, the
  extra satisfaction of consuming an additional
  unit declines
• Relates directly to the negative slope of the
  demand curve

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Factors Causing Demand Curve to Shift

1. Income
2. Tastes and preferences
3. Expectations
4. Population
5. Price of substitutes or complements

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Figure 3-5 Shift in Demand
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Derived Demand

• Derived demand based on the need for a product
  that is indirectly related to consumer demand
• Examples
• fertilizer corn beef
• lumber houses
• tires cars

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Supply The Seller Side of the Market

• Supply the quantities that sellers are willing
  and able to put on the market at different prices

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Figure 3-1 Supply Curve
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Factors Causing Supply Curve to Shift

1. Change in technology
2. Change in price of inputs
3. Weather
4. Change in price of other products that can be
   produced

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Figure 3-2 Shift in Supply
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Changes in Supply

• Change in supply movement of the entire supply
  curve
• Change in quantity supplied movement up or
  down a given supply curve (no shift in curve)

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Short Run Supply vs. Long Run Supply

• Short-run
• marginal costs (MC) must cover average
  variable costs (AVC)(short-run supply MC gt
  AVC)
• Long-run
• marginal costs (MC) must cover average total
  costs (ATC fixed and variable)
• (long-run supply MC gt ATC)

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Figure 3-3 Average and Marginal Cost Curves
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Price Discovery

• Price discovery the process of determining the
  point of market equilibrium (quantity and price)
  where one price and quantity clear the market at
  a given point in time

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Figure 3-6 Market Equilibrium
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Figure 3-7 Change in Market Equilibrium
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Elasticity

• Elasticity of demand reflects the percentage
  change in the quantity demanded when the price
  changes by 1
• Elasticity change in quantity demanded
  change in price

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Levels of Demand Elasticity

• e gt 1.0 Elastic small change in price
  large change in quantity demanded
• e 1.0 Unitary
• e lt 1.0 Inelastic change in price small
  change in quantity demanded

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Example Demand for Bluegrass Seed
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Utility

• Utility (or value) is added to a product through
  the changes transforming a farm product into a
  product the consumer wants

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Types of Utility Added

1. Form utility transforming the products
   characteristics
2. Time utility storage until product is needed
3. Place utility physically moving product to the
   consumer
4. Possession utility allowing the transfer of
   ownership

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Economic Principles to Maximize Profits

• Choose output where marginal cost equals marginal
  revenue MC MR
• Marginal cost the additional cost incurred from
  producing 1 more unit of output
• Marginal revenue the additional revenue
  generated by producing 1 more unit of output

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Example Riverside Orchard Input versus Output
Beehives (input) Apples (bu) (output)
0 200
1 220
2 228
3 234
4 237
5 236
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Example Riverside Orchard Costs and Revenues
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Example Riverside Orchard Terms

• Total variable cost (3) 30/hive
• Total fixed cost (4) 1000
• Total cost (5) variable cost (3)
• fixed cost (4)

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Example Riverside Orchard Terms

• Marginal cost (6) change in total cost ? change
  in output
• Total revenue (7) units sold (2) x
  selling price (6/bu)

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Example Riverside Orchard Terms

• Marginal revenue (8) change in total revenue ?
  change in output
• Profit (9) total revenue (7)
• total cost (5)

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Example Riverside Orchard Decision

• Choose production were MC MR
• In this case, where extra cost of producing one
  more bushel of apples is 5 and the value of
  that bushel is 6
• 3 hives and 234 bushels of apples

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Economic Principles to Maximize Profits

• Choose a combination of inputs where the marginal
  rate of substitution equals the inverse price
  ratio MRS IPR

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Example Producing an 1,100- Pound Steer

• Curtis Brown wants to substitute more hay for
  corn in the feed ration

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Example Producing an 1,100- Pound Steer

Hay (lbs) Corn (lbs) MRS Total ration cost
500 1,300 80.00
600 1,200 1.00 78.00
700 1,125 .75 77.25
800 1,075 .50 77.75
900 1,050 .25 79.50
Assume the price of hay is 3 cents/lb and corn is
5 cents/lb
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Example Producing an 1,100- Pound Steer

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Example Producing an 1,100- Pound Steer

• To choose the least-cost ration, substitute hay
  for corn until MRS IRP
• 700 lbs of hay and 1,125 pounds of corn
• MRS 0.75 (as close as possible to IRP of 0.60
  without being less)

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Economic Principles to Maximize Profits

• Produce different products at levels where there
  are equal marginal returns

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Example Maximizing Sales by Allocating Hours

• Jane Henry, a salesperson, is deciding how many
  hours to allocate to each of her accounts in
  order to maximize her sales (time allocated in
  blocks of 5 hours)

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Example Maximizing Sales by Allocating Hours
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Example Maximizing Sales by Allocating Hours

• Allocate inputs according to equal marginal
  returns
• Allocate 5 hours of call time to the Taylor
  Brothers, Johnson Commercial Growers, and
  Schiek and Company accounts
• Allocate 15 hours to the Bailey Family Farms
  account

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Marketing System Functions

1. Exchange functions product must be bought and
   sold at least once
2. Physical functions transportation, storage,
   processing
3. Facilitating functions market information, risk
   bearing, standardization and grading,
   financing

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Market System Efficiency

• Operational efficiency concerned with the
  physical activities of the marketing system
• OE (Marketing output)/(Marketing input)

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Market System Efficiency

• Pricing efficiency concerned with how
  effectively prices reflect the costs of moving
  output through the marketing system