Transcript Farm Management Chapter 8 Economic Principles - Choosing Input and Output Combinations © Mcgraw-Hill Companies, 2008

Farm Management
Chapter 8
Economic Principles - Choosing Input and
Output Combinations
© Mcgraw-Hill Companies, 2008
Chapter Outline
• Input Combinations
• Enterprise Combinations
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Chapter Objectives
1. Explain the use of substitution in economics
and decision making
2. Demonstrate how to compute a substitution
ratio and a price ratio for two inputs
3. Use the input substitution and price ratios to
find the least-cost combination of two inputs
4. Describe the characteristics of competitive,
supplementary, and complementary enterprises
5. Show the use of the output substitution and
price ratios to find the profit-maximizing
combination of two enterprises
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Input Combinations
Most products require two or more
inputs, and the manager may choose
the input combination or ratio to use.
The economic question is whether
one input can be substituted for
another to reduce the cost.
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Input Substitution Ratio
Input substitution ratio =
amount of input replaced
amount of input added
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Types of Input Substitution
• Constant rate (perfect substitution)
• Decreasing rate
• No substitution
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Figure 8-1
Three possible types of substitution
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Input Price Ratio
Input price ratio =
price of input being added
price of input being replaced
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Decision Rule
input substitution ratio = input price ratio
If they cannot be exactly equal because
of the choices available in the table, get
as close as possible without letting
the price ratio exceed the substitution
ratio.
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Table 8-1
Selecting a Least-Cost Feed Ration
Feed
ration
Grain
(lbs)
Hay
(lbs)
A
B
C
D
E
F
G
825
900
975
1050
1125
1200
1275
1350
1130
935
770
625
525
445
Input
substitution
ratio
2.93
2.60
2.20
1.93
1.33
1.07
>
>
>
>
<
<
Input
price
ratio
Total
cost of
ration
1.47
1.47
1.47
1.47
1.47
1.47
76.80
73.50
70.95
69.30
68.25
68.55
69.45
Each ration puts the same weight gain
on a steer; grain at 4.4¢ and hay at 3.0¢
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With Different Types of Substitution
• With a constant rate of substitution, the
least-cost combination will be all of one
input and none of the other (unless the
price ratio is exactly equal to the constant
rate of substitution).
• With a decreasing rate of substitution, the
least-cost combination will usually include
some of each input.
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Enterprise Combinations
Another decision that must be made
is the combination of enterprises
to produce to maximize profits. If one
or more inputs is limited, there is an
upper limit on how much can be
produced.
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Enterprise Relationships
The first step in determining the
profit-maximizing combination of
enterprises is to determine the
physical relationship among the
enterprises.
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Types of Relationships
• Competitive: output of one enterprise
cannot be increased unless output of the
other decreases
• Supplementary: more output from one
enterprise can be added without a change
in the level of the other enterprise
• Complementary: as output of one
enterprise increases, output of the other
increases also
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Competitive Enterprises
Competitive enterprises may have
constant substitution or increasing
substitution.
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Figure 8-3
Supplementary and complementary
enterprise relationships
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Output Substitution Ratio
Output Substitution Ratio =
quantity of output lost
quantity of output gained
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Output Price Ratio
Output Profit Ratio =
profit of output gained
profit of output lost
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Decision Rule
output substitution ratio = output price ratio
If no available combination makes these
exactly equal, get as close as possible
without letting the price ratio drop below
the substitution ratio.
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Table 8-2
Profit from Various Combinations
of Alfalfa and Grain Sorghum
Acres of
Alfalfa
Acres of
Sorghum
Profit from
Alfalfa ($)
Profit from
Sorghum($)
Total
Profit ($)
0
100
200
300
400
500
600
700
800
1,000
975
925
845
745
620
470
270
0
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
30,000
29,250
27,750
25,350
22,350
18,600
14,100
8,100
0
30,000
34,250
37,750
40,350
42,350
43,600
44,100
43,100
40,000
Profit = $50/acre for alfalfa, $30/acre for sorghum
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Table 8-3
Profit-Maximizing Combination of Two
Competitive Enterprise
Acres of
Alfalfa
Acres of
Sorghum
Output
Substitution
Ratio
0
100
200
300
400
500
600
700
800
1,000
975
925
845
745
620
470
270
0
-0.25
0.50
0.80
1.00
1.25
1.50
2.00
2.70
Profit
Ratio
-1.67
1.67
1.67
1.67
1.67
1.67
1.67
1.67
Profit = $50/acre for alfalfa, $30/acre for sorghum
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Summary
This chapter emphasizes the use of
substitution principles to decide how
and what to produce. To decide
how to produce, the manager finds
the least-cost combination of inputs.
To decide what to produce, the manager
finds the profit-maximizing combination
of enterprises.
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