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Introduction to Agricultural and Natural Resources Introduction to Production and Resource Use FREC 150 Dr. Steven E. Hastings Slide 2 Introduction to Production and Resource Use This Outline Covers the First part of Chapter 6 in Penson et al. Major Topics Production Decisions Types of Resources The Production Function TPP, AVP and MPP Impact of Technology Value Relationships Firms Demand for an Input An Application of Eqi-marginal Return Summary Slide 3 Important Concepts Production Decisions Important Concepts: Production the process of transforming resources into goods and services (again, soil to corn flakes) Resources - inputs (land, management, capital, etc.) Goods and Services provide satisfaction to consumers Important Questions: What to produce? How to produce? How much to produce? Slide 4 Types of Resources (Inputs) Many ways to distinguish resources. By type: land, labor, capital and management. Fixed and Variable this distinction is based on the concept of the producers planning horizon, which varies by producer and/or good or service. A fixed input can not be changed in the short-run. A variable input can be changed in the short run. In the long-run all inputs are variable. Slide 5 The Production Function A model that represents the physical relationship between inputs (fixed and variable) and output. Mathematically Y=f(X1 / X2, X3Xn held constant) Verbally Y is the maximum amount of a good that can be produced with increasing amounts of X1 holding all other inputs, X2, X3Xn, constant given a state of technology. Graphically see Table 6-1 and Figure 6-1 Slide 6 Slide 7 The Production Function Slide 8 Product Curves Total Physical Product (TPP) Average Physical Product (APP) = TPP/X1 Marginal Physical Product (MPP) = TPP / X1 In a normal shaped production function, MPP captures the Law of Diminishing Marginal Productivity as additional amounts of a variable input are added to a set of fixed inputs, the MPP will increase, reach a maximum, and then decrease. Mathematically, MPP is the slope (rise over run) of the TPP. Slide 9 Stages of Production (I, II and III) the APP and MPP allows us to start to narrow in on the optimum amount for the producer to produce. Stage I - APP is increasing (efficiency is increasing) and MPP > APP (getting more from an additional unit than the average unit). Irrational to produce in this area: can increase net revenue by moving to Stage II. Stage II - APP > MPP and MPP is positive. Rational area to produce in. Stage III - MPP is negative. An additional input reduces TPP. Irrational to produce in this area. Slide 10 Stages of Production FREC 150 Economics of Agricultural and Natural Resources Slide 11 Effect of New Technology New technology shifts the production function in a variety of ways. See Figures 3-2 and 3-3 (old book). Typically, allows producer to get more output per unit of input over at least some range of production. Examples: the assembly line for car production (1908) new seed varieties The Green Revolution (1945) new pesticides and herbicides robotic welders Slide 12 Impact of New Technology Slide 13 Slide 14 Value Relationships Physical values (bushels of corn, for example), allow you to identify a range of possible optimal input levels Stage II. To identify the exact amount, need to convert the output (bushel of corn) to dollar value of the output (the value of a bushel of corn). This is done by scaling (or multiplying) TPP, APP and MPP by the price of a bushel of corn what a bushel of corn can be sold for in the market. This converts TPP to Total Value Product or TVP. APP to Average Value Product or AVP, and MPP to Marginal Value Product or MVP. TVP, AVP and MVP are Dollar Values ($$) See Table 6-5 and Figure 6-6. For graphing purposes, the vertical axis is now in Dollars. Slide 15 Value Relationships Correction: 5 is 3 4 In Table 6-5. Slide 16 Most Useful Concept Marginal Value Product (MVP) - the amount added to "revenue" when an additional unit of the variable input is used. MVP = TVP / X1= change in the value of output / unit change in input or = MPP input * P output One Final Thing The Cost of the Input Marginal Factor Cost (MFC or MIC) measures the addition to total cost of an additional unit of an input. MFC input is equal the market price of the input. Slide 17 Optimum Amount of a Variable Input to Use Then optimum amount of a variable input is being used when: MVP input = MFC input The cumulative net benefit (the total revenue over the total cost of using the variable input ) is maximized! See Table 6-5. Slide 18 A Firms Demand for a Variable Input It is the quantity of an input the firm would buy at alternative prices. Specifically, the firm's demand curve for an input is the MVP curve (within Stage II of production), ceteris paribus. The firm's demand for an input is a derived demand. That is, it is derived from the demand for the output produced by the input. Factors that cause the demand for an input to change are: Change in demand (and price ) of the output Change in the productivity of the input Change in the price of other inputs (substitutes and complements) Slide 19 Firms Demand for an Input Slide 20 An Application of the MVP Concept Use of a Resource to Benefit Society The fixed amount (1 million gallons) of water in a reservoir can be used to irrigate corn on a nearby farm or as a coolant in a nearby plant that makes Xs (any product). You are hired by society and put in charge of allocating the water? How should the water be allocated between the two uses? Slide 21 Information Needed If water used to grow corn - If water used to make Xs - Slide 22 Flip the Right Graph! $ $ Water to Farm Water to Plant What is the optimum allocation? Why? Slide 23 Principle of Equi-marginal Returns Principle of Equi-marginal Returns a scarce resource should be allocated between alternative uses so that the marginal returns (in this case, MVPs) are equal in the alternative uses. What if local environmentalists want to keep the water in place for aesthetic purposes? What about fisher-men, -women? What are the implications for how society should allocate scarce resources? Land? Cars? Water? >>> >>> TVs? Forests? Food? Slide 24 Introduction to Production and Resource Use Summary The combination of physical and value (dollar) relationships between inputs and output allows us to make fundamental decisions regarding resource use and allocation in our economic system. Lecture Sources: Text and Miscellaneous Materials