Unit 2: Economic Principles in Agribusiness Lesson: EP3 Substitution Unit 2: Economic Principles in Agribusiness Lesson: EP3

Objectives Lesson Objective: After completing the lesson on substitution, students will demonstrate their ability to apply the concept in real-world situations by obtaining a minimum score of 80% on a Substituting for an Improved School Project. Enabling Objectives: Define substitution and describe the two methods of substitution. Determine maximum profit. Determine and calculate the best rate of substitution.

Key Terms Substitution Maximum profit Constant substitution Variable substitution Marginal rate of substitution Price ratio

What could we use instead?

What could we use instead?

What could we use instead?

What could we use instead?

What could we use instead?

Substitution Replacing one input with another Attempt to maximize profit

Two Methods of Substitution Constant Substitution Substitution at the same rate, one for one Variable Substitution One resource substitutes for part of another Different rates for each additional unit of input

Maximize profits

Maximum Profit Determined by the best combination of inputs Organized in a way so the manager can neither add nor subtract from the business without decreasing profit Determining maximum profit is related to the principle of diminishing returns, in which inputs can only be added up to a certain level without decreasing profit.

Best rate of substitution

Marginal Rate of Substitution Represented as MRS Number of units replaced Number of units added Number of Workers Number of Workers Replaced Number of Machines Number of Machines Added Marginal Rate of Substitution 25 18 7 1 7/1 = 7 13 5 2 5/1 = 5 10 3 3/1 = 3 8 4 2/1 = 2

Price Ratio Represented by PR Price of added unit Price of the replaced unit The cost of a worker is $250 a week, and the cost of owning and operating a machine is $1000 a week. Price ratio is 250/1000 = 4 Number of Workers Number of Workers Replaced Number of Machines Number of Machines Added Marginal Rate of Substitution Price Ratio 25 18 7 1 7/1 = 7 4 13 5 2 5/1 = 5 10 3 3/1 = 3 8 2/1 = 2

Best Rate of Substitution Most profitable combination MRS = PR MRS should always be greater than or equal to PR MRS ≥ PR How many machines should the firm substitute? Number of Workers Number of Workers Replaced Number of Machines Number of Machines Added Marginal Rate of Substitution Price Ratio 25 18 7 1 7/1 = 7 4 13 5 2 5/1 = 5 10 3 3/1 = 3 8 2/1 = 2 2 – if they substitute more, MRS will be less than PR

More practice

Hogs grow best when grain and protein are mixed to obtain the proper protein level. However, they will grow on most any mix of corn and protein. The following rations will all produce about 950 pounds of grain when fed to a pen of ten, 155-pound pigs. If corn costs 3.5 cents/pound and supplement costs 9 cents/pound, what is the least cost ration? Ration Lbs. Corn TC of Corn (.035) Lbs. Protein (.09) TC of Protein Total Cost of Ration A 3500 3500 x .035 = 122.5 100 100 x .09 = 9 131.5 B 2990 104.65 300 27 131.6 C 2560 89.6 500 45 134.60 D 2200 77 700 63 140 E 1900 66.5 900 81 147.5 Ration A

If corn costs 4.3 cents/pound and supplement costs 8 cents/pound, what is the least cost ration? Lbs. Corn TC of Corn (.043) Lbs. Protein (.08) TC of Protein Total Cost of Ration A 3500 150.5 100 8 158.5 B 2990 128.57 300 24 152.57 C 2560 110.08 500 40 150.08 D 2200 94.6 700 56 150.60 E 1900 81.7 900 72 153.70 Ration C

A farmer typically uses dried distillers grain that has 10% moisture; however, he has decided to try substituting this grain for wet distillers grain that has 70% moisture. He would like to know the nutrient equivalent price for the wet distillers grain before he makes the switch. The dry distillers grain sells for $140 per ton. If the dried distillers grain has 10% moisture, there is 90% dry matter. If the wet distillers grain has 70% moisture, there is 30% dry matter. .90 = .30 140 x .90x = 42 x = $46.67 per ton

If dried distillers grain has 10% moisture and sells for $130 per ton, what would be the nutrient equivalent price for wet distillers grain which has 65% moisture? If the dried distillers grain has 10% moisture, there is 90% dry matter. If the wet distillers grain has 65% moisture, there is 35% dry matter. .90 = .35 130 x .90x = 45.5 x = $50.55 per ton

Conclusion An efficient manager may be able to increase a firm’s profits through substitution. The level of substitution is determined by comparing the MRS with the PR and substituting when MRS > PR. The best rate of substitution is when MRS = PR.

What could we use instead?

What could we use instead?

What could we use instead?

What could we use instead?

What could we use instead?

Exit Card What did you learn today about substitution? What questions do you still have about substitution?