Chapter 2 Managing the Agribusiness by ewghwehws

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									Chapter 3:
   Economics for
       Agribusiness Managers
 Definition of Economics

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

Factors of production
  Land
  Labor
  Capital
  Management
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
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.
 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
    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
    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
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
Economic Profit
   Economic profit equals accounting
     profit less opportunity cost
   Calculating economic profit requires
     examining alternative uses of
     resources
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
 Example:
    Determining Economic Profit
Susan’s accounting profit:

Net income of business        $75,000
Salary withdrawal             $35,000
Total accounting profit      $110,000
Example:
   Determining Economic Profit
Alternative uses for Susan’s
    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%)
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
Example:
   Determining Economic Profit


Total accounting profit $110,000
- Total opportunity cost $62,000
= Economic profit        $48,000
Demand:
   The Buyer Side of the Market
Demand: the quantity that buyers
 are willing and able to buy in the
 market at various prices
            Figure 3-4 Demand Curve
                     D1
            40

            30

            20
Price ($)




            10

             0

                 0        100   200       300            400   500   600

                                      Quantity (units)
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
Factors Causing
    Demand Curve to Shift
1.   Income
2.   Tastes and preferences
3.   Expectations
4.   Population
5.   Price of substitutes or
      complements
            Figure 3-5 Shift in Demand
                     D1     D2

            40
Price ($)




            30

            20

            10

             0

                 0    100   200       300            400   500   600

                                  Quantity (units)
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
Supply:
   The Seller Side of the Market
Supply: the quantities that sellers
 are willing and able to put on the
 market at different prices
  Figure 3-1 Supply Curve

            40
Price ($)




            30

            20

            10

             0
                 0   100   200      300      400    500   600   700

                                 Quantity (units)
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
            Figure 3-2 Shift in Supply
                                                                S1

            40
                                                                           S2
Price ($)




            30


            20


            10


             0

                 0   100   200       300      400   500   600        700


                                 Quantity (units)
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)
  Short Run Supply vs.
     Long Run Supply
Short-run:
 marginal costs (MC) must
    cover average variable costs (AVC)
 (short-run supply = MC > AVC)
Long-run:
 marginal costs (MC) must cover average
    total costs (ATC – fixed and variable)
 (long-run supply = MC > ATC)
Figure 3-3 Average and
    Marginal Cost Curves
 Marginal and average costs ($/unit)



                                                                                      MC
                                       40


                                                                         MC > ATC
                                       30


                                                      MC > AVC
                                       20

                                                                                       AT C
                                       10                                                A
                                                                                       AVC
                                                                                         T  A
                                                                                       AFC
                                                                                           AV
                                                                                            C
                                            0   100   200        300      400   500        F
                                                                                           600
                                                                                            C    700

                                                            Quantity (units)               C
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
  Figure 3-6 Market Equilibrium
                             D 2001
                                                      S
Price ($/tractor)




                    P 2001




                                             Q 2001

                                      Quantity
                    Figure 3-7
                        Change in Market Equilibrium
                                      D 2001                  S


                             D 2002
Price ($/tractor)




                    P 2001

                    P 2002




                                          Q 2002    QQ 2001

                                                   Quantity
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
Levels of Demand Elasticity
| e | > 1.0   Elastic: small change in
                 price = large change
                 in quantity demanded
| e | = 1.0   Unitary
| e | < 1.0   Inelastic: change in
                 price = small change
                 in quantity demanded
Example: Demand for Bluegrass
Seed
            50
            0
            40
Price ($)




            30
            20
            10                          D

              0
                  0 100 200 300 400 500
                    00
                     Quantity (100 lb. units)
Utility
Utility (or value) is added to a
 product through the changes
 transforming a farm product into a
 product the consumer wants
Types of Utility Added
1. Form utility: transforming the
    product’s 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
 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
Example: Riverside Orchard
   Input versus Output
   Beehives    Apples (bu)
    (input)     (output)
       0          200
       1          220
       2          228
       3          234
       4          237
       5          236
      Example: Riverside Orchard
         Costs and Revenues
  Bee      Bu. of    Total   Total
 Hives     Apples    Var.    Fixed    Total   Mgl.     Total    Mgl.
(Input)   (Output)   Cost    Cost     Cost    Cost     Rev.     Rev.     Prof.
  (1)       (2)       (3)     (4)      (5)     (6)      (7)     (8)       (9)



  0           200      $ 0   $1,000   $1,00     ----   $1,200     ----   $200
                                          0
  1           220       30    1,000   1,030   $1.50     1,320   $6.00     290

  2           228       60    1,000   1,060    3.75     1,368    6.00     308

  3           234       90    1,000   1,090    5.00     1,404    6.00     314

  4           237      120    1,000   1,120   10.00     1,422    6.00     302

  5           236      150    1,000   1,150     ----    1,416    6.00     266
Example:
   Riverside Orchard Terms
Total variable cost (3) = $30/hive

Total fixed cost (4) = $1000

Total cost (5) = variable cost (3) +
                  fixed cost (4)
Example:
   Riverside Orchard Terms
Marginal cost (6) = change in total
 cost  change in output
       $30  $0
                           $1.50 / bushel
220 bushels - 200 bushels


Total revenue (7) = # units sold (2)
             x selling price ($6/bu)
Example:
   Riverside Orchard Terms
Marginal revenue (8) = change in
    total revenue  change in output

Profit (9) = total revenue (7) –
               total cost (5)
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
Economic Principles to
   Maximize Profits
Choose a combination of inputs
   where the marginal rate of
   substitution equals the inverse
   price ratio:
              MRS = IPR
Example: Producing an
   1,100- Pound Steer
Curtis Brown wants to substitute
 more hay for corn in the feed
 ration
   Example: Producing an
      1,100- Pound Steer
                                                      Total
  Hay (lbs)       Corn (lbs)           MRS
                                                   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
  Example: Producing an
     1,100- Pound Steer

                     change in amount of corn
MRS hay for corn   
                     change in amount of hay



  IPR  price of hay  $0.03/pound  0.60
       price of corn $0.05/pound
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)
Economic Principles to
   Maximize Profits
Produce different products at levels
   where there are equal marginal
   returns
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)
      Example: Maximizing Sales by
         Allocating Hours
 Sls
                            JJohnson
Call        Taylor                         Schiek        Bailey
                           Commercial
Time       Brothers                     and Company   Family Farms
                            Growers
(hrs)

        Sales     MR      Sales   MR    Sales   MR    Sales    MR

  0      64           -    75      -     79      -      65     -
  5      70           6    81      6     85      6      75     10
 10      75           5    86      5     89      4      83     8
 15      79           4    90      4     92      3      89     6
 20      82           3    92      2     93      1      93     4
 25      84           2    93      1     93      0      95     2
 30      85           1    93      0     93      0      96     1
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
 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
Market System Efficiency
1. Operational efficiency: concerned
    with the physical activities of the
    marketing system

  OE = (Marketing output)/(Marketing input)
Market System Efficiency
2. Pricing efficiency: concerned with
    how effectively prices reflect the
    costs of moving output through
    the marketing system

								
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