LECTURE VI PROFIT MAXIMIZATION

Profit Maximization  Revenue is  Viewed from the standpoint of either input or output.  Income to the producer is  Measured in terms of either revenue per unit of input or revenue per unit of output.  Profit is maximized when total revenue exceeds total costs

Profit Maximization  Total revenue = Amount of product sold X product price.  If there are too many farmers, no one producer can influence the product price appreciably.  This means that the only way individual farmers can increase their total revenue without changing quality of product is to increase their total production.  This revenue relationship is referred to as a linear one, i.e. a straight-line relationship.

Profit Maximization  Profits are maximized when the total revenue from the sale of the last unit of output just equals the costs necessary to produce it.  At this point, marginal costs equal marginal revenue (MC=MR).  This is the least cost point of production.  Net profit is determined by total revenue (TR) minus total costs (TC).  Net profit is greatest when the difference between TR and TC is greatest.

Selecting and Combining Enterprises  Most farmers grow a variety of crops and may keep some livestock.  Mixtures of crops are grown on the same plot in the same season, a practice known as mixed-cropping or inter-cropping.  The types of plant and animal enterprises that are profitable for any farmer/manager are determined to a large degree by the law of comparative advantage.

Selecting and Combining Enterprises  Farmers must  Determine/develop the cropping system.  Develop the livestock programme.  The choice of enterprise(s) depends in part  On the farmer’s personal preferences and family goals  Upon the farm manager’s ability to apply technical expertise and economic reasoning,  Upon the resources with which the managers must work.

Selecting and Combining Enterprises  Choices of products are t made based various considerations including:  Production possibilities of the products  Constraints and Feasible area  Maximization of returns  Subjective Preferences  Food versus Cash Crops  Specialization versus diversification

Production possibilities of the products  Where two crops are competitive the expansion of one has a “cost” in terms of the amount of the alternative foregone.  This is a measure of opportunity cost.  Resources of land, labour and homemade capital has opportunity costs though they may not have a market price.

Production possibilities of the products  Production possibility boundaries may be drawn for any pair of alternative products, crop or livestock.  The slope of the curve of a possibility curve will measure of the rate at which one product can replace another and is known as the rate of product transformation (RPT).

Constraints and Feasible area  Limitations of space, soil moisture and various plant nutrients are constraints on crop growth, but the crops compete at different rates for them.  Mixed cropping is one of the ways to overcome these constraints as it:  Increases the utilization of environmental factors such as light, water and nutrients as different crops have different water and nutrient requirements and different rooting habits.  Enhances better control of weeds, pests and diseases.  Enhances soil protection

Maximization of returns  Assuming that the objective of the farmer is to maximize returns, he/she endavour to produce at the level where he/she has the least-cost combination.  He/she will produce at the point of economic optimum.

Subjective Preferences  It is not always that a farmer produces for the mere objective of maximizing financial gains.  Farmer could be concerned with  Finding a single, best combination or maximizing anything so long as he/she can meet his/her minimum goals.  Ranking objectives in order of priority to meet family objectives.  Maximizing utility

Food versus Cash Crops  Assuming that the farmer, though not committed to mixed cropping, is endowed with limited resources, he/she must choose between competing uses of these resources.  For example he/she must choose whether to grow maize for food or coffee for cash.  In practice, there are choices to be made not simply between cash production and food production but between a whole range of consumption goods and a large array of production processes

Specialization versus diversification  Depending on whether the farmer is a large scale or small-scale producer, there are advantages in specialization and devoting all available resources to that activity where economies of scale exist.  However, diversification into more than one productive activity has several potential advantages.

Advantages of Diversification  Given that some inputs are fixed, marginal returns are likely to diminish as more and more are devoted to a single product.  Higher marginal returns and hence more total product are obtained by devoting some of the inputs to an alternative crop or livestock activity.  Complementary and supplementary relationships between alternative products means that the combined output of both from a given set of resource is greater that that of either one on its own.

Advantages of Diversification  Exploiting available resources up to their limits can increase total production, which means making the constraints effective.  This then will involve a combination of productive activities.  Where subjective choice is involved, as in choosing what crops to grow for home consumption, a variety of products are likely to be preferred over a single one.  Risk may be reduced by diversification.