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Producer Decision Making

Producer Decision Making. Two - Variable Inputs and Enterprise Selection. Chapter 5. Three Types of Relationships Producers Must Understand. 1 Factor - Product relationship deals with choosing the level of an input, in order to be efficient. .

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Producer Decision Making

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  1. Producer Decision Making Two - Variable Inputs and Enterprise Selection Chapter 5

  2. Three Types of Relationships Producers Must Understand 1 Factor - Product relationship deals with choosing the level of an input, in order to be efficient. 2 Factor - Factor relationship deals with choosing between competing factors. 3 Product - Product relationship deals with choosing between competing products.

  3. Choosing the optimal proportion of the inputs in order to efficiently produce output. Factor - Factor

  4. A two - variable input production function can take on the following form: Y = f (X1, X2) where X1 and X2 can vary in amounts Two-Variable Input Functions

  5. Two-Variable Input Functions A two - variable input production function can also take on another form: Y = f (X1, X2 X3, X4) where X1 and X2 can vary in amounts and X3, X4 are fixed.

  6. . . . . . A B C D E X1 X2 Y Isoproduct Contours (Isoquants)

  7. Isoproduct Contours X2 Perfect Substitutes Y X1

  8. Isoproduct Contours Perfect Substitutes Perfect substitutes are able to replace one another without affecting output. For every unit decrease in one input a constant unit increase in the other input will hold output at the same level. Example : Water From Well 1and Water fromWell 2

  9. Isoproduct Contours X2 Perfect Complements Y X1

  10. Isoproduct Contours Perfect Complements Perfect Complements must be used in a constant proportion to be efficient. Therefore, an additional amount of one resource will do nothing for output. There is no decision for the determining the ratio of use. Example: Tractor and Plow.

  11. Isoproduct Contours X2 Imperfect Substitutes Y X1

  12. Imperfect Substitutes The most common problem faced by producers. Factors will substitute for one another, but not at a constant rate. Successive equal incremental reductions in one input, must be matched by increasingly larger increases in the other input in order to hold output constant. This is what gives the curved shape to the isoquant.

  13. Imperfect Substitutes Example: Land and Fertilizer As we decrease available land, we must use increasingly more fertilizer to make up for the lost land.

  14. Imperfect Substitutes

  15. Is the rate at which resources substitute for one another. Marginal Rate of Substitution

  16. Marginal Rate of Substitution Is the rate at which resources substitute for one another. ∆ ∆ MRTS X1,X2 = X2 / X1 This ignores the sign

  17. Marginal Rate of Substitution Diminishing Marginal Rate of Substitution - as one input is increased one unit at a time, the units of the other inputs needed to produce the same level of output become fewer.

  18. Diminishing Marginal Rate of Substitution X2 ∆ X2 Y X1 ∆ X1

  19. Diminishing Marginal Rate of Substitution X2 ∆ X2 Y X1 ∆ X1

  20. Diminishing Marginal Rate of Substitution X2 Y ∆ X2 X1 ∆ X1

  21. Diminishing Marginal Rate of Substitution X2 ∆ X2 Y=50 Y=25 X1

  22. What is the Optimum or Least Cost Combination of inputs to use? Water 100 lbs. Cotton Fertilizer

  23. Least Cost Combination Water Fertilizer $ .50 lb Water $ .10 Gallon 125 $ 10 spent on inputs 100 75 50 25 100 lbs. Cotton 5 10 15 20 Fertilizer

  24. Least Cost Combination Water Fertilizer $ .50 lb 125 Water $ .10 Gallon $ 10 spent on inputs 100 75 50 . 25 100 lbs. Cotton Fertilizer 5 10 15 20 25

  25. Least Cost Combination Water Fertilizer $ .50 lb . Water $ .10 Gallon 125 $ 10 spent on inputs 100 75 50 25 . 100 lbs. Cotton Fertilizer 5 10 15 20 25

  26. Least Cost Combination Water Fertilizer $ .50 lb . Water $ .10 Gallon 125 $ 10 spent on inputs 100 75 50 25 . 100 lbs. Cotton Fertilizer 5 10 15 20 25

  27. Least Cost Combination Water Fertilizer $ .50 lb . 125 Water $ .10 Gallon 100 $ 10 spent on inputs 75 Optimal input level . 12 lbs. Fertilizer 50 40 Gal. Water . 25 100 lbs. Cotton 5 10 15 20 25 Fertilizer

  28. Change in Price of input Water Fertilizer $ .50 lb 125 Water $ .20 Gallon 100 $ 10 spent on inputs 75 . Optimal input level 16 lbs. Fertilizer 50 10 Gal. Water . 25 . 100 lbs. Cotton Fertilizer 5 10 15 20 25

  29. Change in Price of input Water Fertilizer $ .50 lb 125 80 lbs. Cotton Water $ .20 Gallon 100 $ 10 spent on inputs 75 . Optimal input level 16 lbs. Fertilizer 50 10 Gal. Water . 25 . 100 lbs. Cotton Fertilizer 5 10 15 20 25

  30. Product - Product Choosing the optimal combination of products to produce given fixed amounts of land, labor, capital and management.

  31. Product - Product Production Possibilities - The full range of products a farm can produce given the set of resources in the farm's control.

  32. Product - Product Soybeans 1000 Bushels 7 6 5 4 3 2 1 Grain Sorghum 1000 bushels 2 4 6 8 10 12

  33. Product - Product Marginal Rate of Product Substitution Measures the differing rates at which either of the products will replace (substitute for) the other along the production possibilities curve.

  34. Product - Product Marginal Rate of Product Substitution Measures the differing rates at which either of the products will replace (substitute for) the other along the production possibilities curve. MRPS Y1 Y2 = Y2 / Y1

  35. Product - Product Y2 Y2 7 Y1 6 5 4 3 2 1 Y1 2 4 6 8 10 12

  36. Product - Product Soybeans 1000 Bushels 7 . 6 A 5 4 3 2 1 Grain Sorghum 1000 bushels 2 4 6 8 10 12

  37. Product - Product Soybeans 1000 Bushels 7 6 5 4 . 3 B 2 1 Grain Sorghum 1000 bushels 2 4 6 8 10 12

  38. Product - Product Soybeans 1000 Bushels Isorevenue Line— Finding the optimum combination 7 6 5 Price Grain Sorghum $2.50 4 Price Soybeans $3.75 3 2 1 Grain Sorghum 1000 bushels 2 4 6 8 10 12

  39. Isorevenue Line Soybeans 1000 Bushels . 7 Price Grain Sorghum $2.50 6 Price Soybeans $3.75 5 Isorevenue Line $22,500 4 $22,500 = 6,000 SB 3 $3.75 2 1 Grain Sorghum 1000 bushels 2 4 6 8 10 12

  40. Isorevenue Line Soybeans 1000 Bushels . Price Grain Sorghum $2.50 7 Price Soybeans $3.75 6 Isorevenue Line $22,500 5 $22,500 = 9,000 GS $2.50 4 3 2 . 1 Grain Sorghum 1000 bushels 2 4 6 8 10 12

  41. Isorevenue Line Soybeans 1000 Bushels . 7 Price Grain Sorghum $2.50 6 Price Soybeans $3.75 5 Isorevenue Line $22,500 4 Slope = PY1 3 PY2 2 . 1 Grain Sorghum 1000 bushels 2 4 6 8 10 12

  42. Isorevenue Line Soybeans 1000 Bushels 7 Price Grain Sorghum $2.50 6 Price Soybeans $3.75 5 4 3 2 1 Grain Sorghum 1000 bushels 2 4 6 8 10 12

  43. Isorevenue Line Soybeans 1000 Bushels Price Grain Sorghum $2.50 7 Price Soybeans $3.75 6 5 4 3 2 1 Grain Sorghum 1000 bushels 2 4 6 8 10 12

  44. Point of Revenue Maximization Y2 / Y1 = PY1 / PY2 Y2 Y2 Y1 PY1 / PY2 Y1

  45. Isorevenue Line - Optimum Soybeans 1000 Bushels Price Grain Sorghum $2.50 7 Price Soybeans $3.75 6 Farmer would produce 5 9,000 bushels GS . 4,000 bushels SB 4 Revenue = ? 3 2 1 Grain Sorghum 1000 bushels 2 4 6 8 10 12

  46. Isorevenue Line - Optimum Soybeans 1000 Bushels Price Grain Sorghum $2.50 7 Price Soybeans $3.75 6 Farmer would produce 5 9,000 bushels GS . 4,000 bushels SB 4 Revenue = $37,500 3 2 1 Grain Sorghum 1000 bushels 2 4 6 8 10 12

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