1. AAMP Training Materials
Module 1.1: Production Cost and Farm Productivity
Steven Haggblade (MSU)
This is the first section of the Smallholder Productivity Unit which is part of the AAMP Training Materials.
Exercises in this presentation are found in the excel spreadsheet entitled:
Production Cost and Farm Productivity.xls

2. Module Contents
Objectives
Background material
Exercises
Conclusions

3. Objectives Understand what determines the price level of a good
Compute plot-level production costs and compare between farmers
Explore what affects farm productivity using estimate yield functions
Examine policy implications (for stimulating agricultural growth & government procurement pricing)

4. Background Material Review determinants of price
What factors affect the cost of supplying maize to the market?
Why does productivity vary across farms?

5. Determinants of price
The price of a good is set by supply and demand.

6. Determinants of price (contd.)
An increase in supply lowers the price of the good. Here, an increase in output from Q0 to Q1 drops the price from it’s original position at P0 to P1.
The quantity of maize supplied to the market depends upon farmers’ ability to keep production costs per hectare low.

7. What affects the cost of supplying maize to the market?
Farm-level cost of production
Transport costs (distance to market)
Marketing costs (handling, storage, profit, risk premium)
Farmers encounter a number of costs in the production and marketing of crops, costs that affect the amount of maize brought to the market and the eventual market price.
Farm-level production costs include seed and fertilizer purchase, labor payments, repair and maintenance of machinery etc. Productivity among farmers is not constant, however, and the most efficient farmers maximize margins by keeping costs low.
After the harvest, farmers face additional costs related to transport and marketing. The farther a farmer has to go to sell his/her goods, the higher the cost. Additionally, marketing costs in the form of handling charges, storage payments, profit margins and risk premium all increase the eventual price of the good. That being said, the focus of this presentation and the accompanying exercises is on farm level costs and productivity.

8. Why does productivity vary…
Among farmers?
Across plots?
Farm productivity refers to a farmer’s ability to produce a large yield (kg/hectare) at low cost. Productivity varies widely among smallholder farmers.
Q: Is this a good farmer or a bad farmer?

9. Productivity varies partly because farmers differ in terms of skill level. A skilled farmer will make efficient use of inputs and will be able to follow advice. He/she will increase yields by planting and weeding on time, and by making appropriate use of technology.
Good farmer? Bad farmer?

10. Lesser skilled farmers will incur higher costs and/or lower yields than a skilled farmer.
Good farmer? Bad farmer?

11. Good farmer? Bad farmer?

12. Where are the good farmers and bad farmers on this supply curve?
In the figure above, there are two circles representing two different farmers. One circle represents a good farmer (one who is very efficient) while the other represents a bad farmer (one who is very inefficient). Which is which? How do you know?
Supply is related to a farmer’s cost. If P0 is greater than the cost a farmer incurs to produce maize, then a farmer who sells to the market will profit from maize production. If P0 is less than what a farmer spends to produce maize, then the farmer can sell only at a loss.
Therefore, the green circle on the left represents an efficient farmer who can sell at P0 at a profit, and the red circle on the right represents an inefficient farmer who will take a loss at P0.

13. Exercise 1: Compute Plot-level Cost
Open “Production Cost and Price Variability.xls”
Read the red NOTES tab to familiarize yourself with the contents of the workbook
Click on the [data1 – plots] tab and explore the data
There are 200 farmers represented
Focus on yield
Why is yield so variable?
The Excel based exercises are the backbone of this module. Take time to familiarize yourself with the data and exercises in the workbook. The NOTES sheet contains important information about the sheets in the workbook. You will notice that tabs are color coded. Gray tabs are raw data and blue tabs are exercises.
The data in [data1 – plots] shows a high degree of variability among farmers in every aspect of their production. Yield varies greatly, affected by farmers resources and skill levels.

14. Exercise 1: Compute Plot-level Cost contd.
Click on the [ex 1 – cost of production] tab
Values in yellow refer to [data1 – plot]
Values in green are results
What do you notice?
On average, do farmers have positive revenue?
What are the major costs?
Compare farm productivity between farms
Select a farmer from [data1 – plot]
Link the yellow highlighted values to a farm in [data1 – plot]
How does this compare to the mean?
Repeat for several different farms
How do they compare to each other?
After opening [ex 1 – cost of production], take a moment to see what the highlighted values refer to. To begin, ensure that the yellow highlighted values refer to the means at the bottom of [data1 – plot].
If working with others, have each person record the results from their chosen farm for comparison.

15. Exercise 1: Results Farm productivity varies greatly
Some farmers in the sample receive negative revenue from maize
Policy should focus on increasing farmer productivity
Raises farmers’ profits
Lowers consumer costs

16. Exercise 2: Cost Histogram & Supply Curve
Examine the Cost Histogram in [ex 2 – cost groups]
What do you see?
Can you make generalizations about “smallholder production costs” based on this histogram?
Clearly, production costs vary widely between farms. The most efficient farmers are able to produce one ton of maize for less than $50, while the least efficient spend greater than $400 per ton.
On average, the group spends $152 per ton.

17. Exercise 2: Cost Histogram & Supply Curve
Next, examine columns Z, AA & AB in [data4 – cost per ton]
Copy column AB (tot_cost_ton) from [data4 – cost per ton] and paste it into [ex 2 – cost per ton]
Sort the column in ascending order (small values to large values)
Select the entire column and make a line chart
What does this chart show?
Compare with the chart in slide 11 of this presentation
If you were asked to choose a “fair maize price” based on this chart, what price would you choose?
Column AB shows the total cost of production for the 200 farmers in the sample. When plotted in ascending order, an upward sloping line appears which is an approximation of the group’s supply curve.
Price setting is not ideal. If the price is set too high, inefficient farmers supply too much maize to the market at great cost. If the price is too low, not enough maize reaches the market and some efficient farmers are left out.

18. Exercise 2: Results
Individual farmers’ cost of production varies greatly
Setting a price floor based on production costs has several problems
Who decides what’s “fair”? Where do you draw the line?
Set the price too high  government buys large volumes from inefficient farmers
High price risks pushing out private traders & hurting consumers
Policy that focuses on lowering farmers’ cost of production evades these problems

19. Exercise 3: Estimate Plot-level Yield Function
What are the factors affecting plot-level yield?
Seed Type (high yielding varieties vs. local)
Fertilizer application (kg/ha)
Time of planting (number of days after November 1)
Tillage system (hand hoe, conservation farming basins, plowing, ripper)
Number of years experience with conservation farming
Plot size
Gender
Yield = a + b Fert + c HYV + d Till + …
Yield is a function of Fertilizer, seed type, tillage type etc....

20. Exercise 3: Regression Equation
Open a new sheet in Excel
Use the Regression Tool to estimate the yield function
See notes in this presentation, as well as the NOTES tab in the Excel workbook for tips
Examine the coefficients
Which variables have the most impact on maize yield?
Are there any surprises?
How can this information be used in agricultural policy?
Research?
Extension?
The Yield Regression Summary Output in [ex 3 – regression] was computed using data in [data1 – plots] and can be replicated using the Regression command in Excel (see NOTES).
Where…
Y = yield (column G)
Xs = columns H – P

21. Exercise 3: Interpreting Regression Coefficients
Regression coefficients on continuous variables indicate the change in maize yield with respect to a change in each of the variables, holding all others constant. The figure above shows that an increase in fertilizer application results in an increase in maize yield. In the spreadsheet example, the regression coefficient on fert_ha in the [ex 3 – regression] page shows a similar positive relationship.

22. Exercise 3: Interpreting Regression Coefficients
The figure above shows the effect HYV maize seed has on maize yield.
Farmers planting HYV seeds rather than local varieties experience a positive shift in maize yield.

23. Exercise 3: Results
High yielding seed varieties, planting basins, and fertilizer have a positive impact
Which has the biggest impact?
Which is cost effective? Look at the coefficient on fertilizer… is that a big enough increase in yield to justify the cost?
The planting date variable has a strong negative impact.
Highlights the importance of timeliness in agriculture.
What does this mean for agricultural extension?
The Summary Output indicates that for the 200 farmers in the data set, the presence of High Yielding Varieties of maize seed, application of fertilizer, and use of planting basins had a positive and statistically significant impact on maize yield.
However, that’s not the whole story. Look at [data2 – prices]. Compare the cost of fertilizer per kg to the price of maize per kg. At these prices, according to the coefficient on fert_ha, an additional kg of fertilizer brings the farmer 1.4 extra kilograms of maize, or about $ BUT the cost of that kg of fertilizer is $0.56! So, while one kg of fertilizer increases yields a little, it reduces profits a lot! Fertilizer alone at these prices is not profitable.
Hybrid seeds, on the other hand, have a much stronger effect on maize yield giving a farmer approximately 532 kgs extra per hectare which amounts to $95.76 which is well above the cost of the seed (about $18). Because fertilizer has a much stronger effect on hyv maize, a farmer using the two inputs in combination should reap a substantial yield.
Importantly, the planting date variable shows a strong negative relationship with maize yield. For every day a farmer delays planting after the optimal plant date (set at November 1), maize yield decreased by 22 kg. If a farmer delays a week, he loses three bags of maize worth $27.

24. Conclusions: empirical
Cost of production differs across farmers and plots
Efficient farmers produce at lowest cost

25. Conclusions: policy
Raising farm productivity  higher farmer profits and lower costs to consumers
Key public investments for lowering farmers’ cost of production
Agricultural research (breeding, agronomy)
Extension (improves agronomic and management practices)
Infrastructure improvements (lowers input cost prices)
If government sets procurement prices…
High price  large volumes procured. Purchases made from inefficient farmers
Low price  lower volumes procured. Purchases made only from efficient farmers

26. References
Chirwa, E Sources of Technical Efficiency among Smallholder Maize Farmers in Southern Malawi. AERC Research Paper Nairobi: African Economic Research Consortium.