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Cost & Return Analysis

Cost & Return Analysis. Farm & Ranch Business Management Chapter #5. Production Function. As inputs are changed, outputs are changed also Example: fertilizing wheat. Where is the maximum profit?. Lbs. Of Fertilizer Yield 0 20 20 25 40 32 60 40 80 45

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Cost & Return Analysis

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  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 don’t 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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