cost & return analysis
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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 FertilizerYield 020 2025 4032 6040 8045 - PowerPoint PPT PresentationTRANSCRIPT
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Cost & Return Analysis
Farm & Ranch Business ManagementChapter #5
Farm & Ranch Business ManagementChapter #5
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Production Function
As inputs are changed, outputs are changed also
Example: fertilizing wheat
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Where is the maximum profit?
Lbs. Of Fertilizer Yield0 2020 2540 3260 4080 45100 48120 45
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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
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Law of Diminishing Returns
Lbs. Of Fertilizer Yield Added0 20 020 25 540 32 760 40 880 45 5100 48 3120 45 -3
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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
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Stage #1 Example
Lbs. Of Fert. Yield Added Avg Prod.0 20 0 2020 25 5 2540 32 7 1660 40 8 13.380 45 5 11.1100 48 3 9.2120 45 -3 7.5
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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
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Stage #3 of the Production Function
Lbs. Of Fert. Yield Added Avg Prod.0 20 0 2020 25 5 2540 32 7 1660 40 8 13.380 45 5 11.1100 48 3 9.2120 45 -3 7.5
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How much fertilizer?
Lbs. Of Fert. Yield Added Avg Prod.0 20 0 2020 25 5 2540 32 7 1660 40 8 13.380 45 5 11.1100 48 3 9.2120 45 -3 7.5
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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.
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Profit Maximizing RuleFert. Total Yield
Lbs. Cost Yield Added Val.Add Avg Prod.0 20 0 2020 $10 25 5 $15 2540 $10 32 7 $21 1660 $10 40 8 $24 13.380 $10 45 5 $15 11.1100 $10 48 3 $9 9.2120 $10 45 -3 $-9 7.5
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Profit Maximizing RuleFert. Total Yield
Lbs. Cost Yield Added Val.Add Avg Prod.0 20 0 2020 $15 25 5 $12.50 2540 $15 32 7 $17.50 1660 $15 40 8 $20 13.380 $15 45 5 $12.50 11.1100 $15 48 3 $7.50 9.2120 $15 45 -3 $-7.50 7.5
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Fixed Costs
Not used in profit maximizing rule Must be considered to determine if you will
make a profit or not
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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)
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Least Cost: Mathematical Approach
If one input (soybean meal) can be substituted for another (corn)
Usually don’t substitute at equal ratesChange in corn = Price of SBMChange 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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