AAEC 2305 Fundamentals of Ag Economics ___________________________ Chapter 6 - Continued

 Maximization: Input Basis _______________________________________________________________________________________________ Objective is to determine level of input use that will maximize .Objective is to determine level of input use that will maximize . Achieved by comparing value of output produced to value of inputs used.Achieved by comparing value of output produced to value of inputs used. Product curves from ch. 2 show relationship between input use and physical pdn – by multiplying each product curve by P y – pdn measured on an output basis can be translated to pdn measured on a value (monetary) basis – we can now show relationship between input use and value of pdn.Product curves from ch. 2 show relationship between input use and physical pdn – by multiplying each product curve by P y – pdn measured on an output basis can be translated to pdn measured on a value (monetary) basis – we can now show relationship between input use and value of pdn.

Revenue Product Curves _______________________________________________________________________________________________ Total Revenue Product (TRP) – Dollar value of output produced from alternative levels of variable input.Total Revenue Product (TRP) – Dollar value of output produced from alternative levels of variable input. –Also called Total Value Product (TVP) –TRP = TPP * P y

Revenue Product Curves _______________________________________________________________________________________________ Average Revenue Product (ARP) – average value of output per-unit of input at each input levelAverage Revenue Product (ARP) – average value of output per-unit of input at each input level –Also called Average Variable Product (AVP) –ARP = APP * Py

Revenue Product Curves _______________________________________________________________________________________________ Marginal Revenue Product (MRP) – additional (marginal) value of output obtained from each additional unit of variable inputMarginal Revenue Product (MRP) – additional (marginal) value of output obtained from each additional unit of variable input –Also called Marginal Value Product (MVP) or Value of Marginal Product (VMP) –MRP = ΔTRP / ΔX = MPP*P y Diagram Revenue Product CurvesDiagram Revenue Product Curves

Marginal Factor Cost (MFC) _______________________________________________________________________________________________ MFC – cost of an additional unit of input or amount added to total cost from using one more unit of variable input (P x )MFC – cost of an additional unit of input or amount added to total cost from using one more unit of variable input (P x ) –Because the firm is assumed to be a price taker and Px is fixed – MFC is graphed as a horizontal line

Marginal Factor Cost _______________________________________________________________________________________________ NOTE: MFC  MCNOTE: MFC  MC –MC is calculated on the basis of a change in output - (change in total cost divided by the change in output) –MFC is calculated on the basis of a change in input use and is always Px – (change in total cost divided by the change in input use)

Economic Rule _______________________________________________________________________________________________ Producer determines how much input to use by comparing the value of output produced by each input level to the cost of using that input level.Producer determines how much input to use by comparing the value of output produced by each input level to the cost of using that input level. ** Producer should continue to use additional units of input until the additional value of output received from using an additional unit of input is equal to (or slightly larger than) the cost of using that unit of input – or comparing MRP to MFC such that MRP  MFC** Producer should continue to use additional units of input until the additional value of output received from using an additional unit of input is equal to (or slightly larger than) the cost of using that unit of input – or comparing MRP to MFC such that MRP  MFC

Continued _______________________________________________________________________________________________ If the additional value of output received from using an additional unit of input is less than the cost of that input, the firm will not use that unit of inputIf the additional value of output received from using an additional unit of input is less than the cost of that input, the firm will not use that unit of input

Firm’s Demand Curve for Variable Input _______________________________________________________________________________________________ The MRP curve provides us with information of how much of an input will be utilized or demanded at various prices for that input – this is referred to as Factor Demand.The MRP curve provides us with information of how much of an input will be utilized or demanded at various prices for that input – this is referred to as Factor Demand. The demand for an input reflects the value that input adds to revenue, or its MRP.The demand for an input reflects the value that input adds to revenue, or its MRP.

Firm’s Demand Curve for Variable Input _______________________________________________________________________________________________ As the price of an input changes, the quantity of input used (or demanded) by the firm also changesAs the price of an input changes, the quantity of input used (or demanded) by the firm also changes Hence, using  ’s in input price level & the decision rule MRP  MFC, we can trace the firm's demand schedule for that input holding all other inputs and their prices constantHence, using  ’s in input price level & the decision rule MRP  MFC, we can trace the firm's demand schedule for that input holding all other inputs and their prices constant

Position of Firm’s Demand Curves for Variable Input _______________________________________________________________________________________________ Since MRP = MPP * P y, the position of the firm’s factor demand curve depends on both Py and the underlying pdn function.Since MRP = MPP * P y, the position of the firm’s factor demand curve depends on both Py and the underlying pdn function. Therefore, a  in either TPP or P y will cause the MRP curve to shift.Therefore, a  in either TPP or P y will cause the MRP curve to shift.

Production of Multiple Outputs _______________________________________________________________________________________________ If a firm is producing two products – How does it decide how much of each to produce?If a firm is producing two products – How does it decide how much of each to produce? The decision depends on the degree of:The decision depends on the degree of: 1) Supplementarity 2) Complementarity 3) Competition between the two goods.

Production Possibilities Frontier _______________________________________________________________________________________________ Production Possibilities Frontier (PPF) – a curve depicting the maximum amount of various combinations of two products that can be produced using a given (or fixed) level of inputs.Production Possibilities Frontier (PPF) – a curve depicting the maximum amount of various combinations of two products that can be produced using a given (or fixed) level of inputs. Marginal Rate of Product Substitution (MRPS) – measures the slope of the PPFMarginal Rate of Product Substitution (MRPS) – measures the slope of the PPF MRPS describes the rate at which one output must be decreased as production of the other product is increased.MRPS describes the rate at which one output must be decreased as production of the other product is increased. MRPS = Δ Y1 / Δ Y2MRPS = Δ Y1 / Δ Y2

(continued) _______________________________________________________________________________________________ The curve is called a frontier because it shows the maximum that can be produced.The curve is called a frontier because it shows the maximum that can be produced. The curve of the PPF is the result of the law of diminishing marginal returns.The curve of the PPF is the result of the law of diminishing marginal returns. The shape of the curve indicates that the goods are substitutes in production, which means they compete for resources in production.The shape of the curve indicates that the goods are substitutes in production, which means they compete for resources in production.

Possible PPF Relationships _______________________________________________________________________________________________ Competition – occurs when increasing the output of one product reduces the output of the other.Competition – occurs when increasing the output of one product reduces the output of the other. Complementary – occurs when increasing the output of one product increases the output of the other.Complementary – occurs when increasing the output of one product increases the output of the other. Supplementary – occurs when the two products use different resources or the same resources at different times.Supplementary – occurs when the two products use different resources or the same resources at different times.

Isorevenue Line _______________________________________________________________________________________________ Isorevenue line – a line depicting all combinations of two products that will generate a given (or same) level of total revenue.Isorevenue line – a line depicting all combinations of two products that will generate a given (or same) level of total revenue. –Slope of the Isorevenue line is equal to the negative inverse of the price ratios.

Production of Multiple Outputs _______________________________________________________________________________________________ The firm maximizes profit by operating where the isorevenue line is tangent to the PPF.The firm maximizes profit by operating where the isorevenue line is tangent to the PPF. Therefore, the profit-maximizing output levels occur where the slope of the PPF equals the slope of the isorevenue line.Therefore, the profit-maximizing output levels occur where the slope of the PPF equals the slope of the isorevenue line.