Chapter 3: Economics for Agribusiness Managers

Definition of Economics The study of how scarce resources are combined to meet the needs of people in a society of unlimited wants.

Scarce Resources Factors of production Land Labor Capital Management

The US: A Market-Oriented Capitalistic Economy Market-oriented: Consumers make wants known by voting with their dollars Producers respond by adjusting production and products offered

Capitalism A system in which property is owned and controlled by private citizens. Any profits generated by the use of the property belongs to the owner.

Why Profits Exist in Our Economy 1.Profits are the reward for taking a risk in business 2.Profits result from the control of scarce resources 3.Profits exist because not all information is widespread 4.Profits occur when a business is managed better than others

Macroeconomics: The Big Picture Macroeconomics is concerned with how the different elements of the total economy interact Examples that impact agribusinesses: Monetary policy Fiscal policy International development

Microeconomics: Economics Within the Firm Microeconomics is the application of basic economic principles to decisions within the firm Example of microeconomic decisions: How to best use physical, human, and financial resources to meet customers needs and generate a profit

Opportunity Cost The income given up by not choosing the next best alternative for the use of the resources Opportunity costs are never actually incurred and cannot be measured precisely

Economic Profit Economic profit equals accounting profit less opportunity cost Calculating economic profit requires examining alternative uses of resources

Example: Determining Economic Profit Situation: Susan Lambert owns/operates a landscaping firm She wants to determine her economic return for operating this firm Susan is 30 years old She has $400,000 invested in the business She makes a salary of $35,000 The business made $75,000 profit last year

Example: Determining Economic Profit Susans accounting profit: Net income of business$75,000 Salary withdrawal$35,000 Total accounting profit$110,000

Example: Determining Economic Profit Alternative uses for Susans economic resources: Sell business, work for someone else making $30,000 annually Reinvest $400,000 investment in: savings account (5%), government bonds (6%), corporate bonds (8%)

Example: Determining Economic Profit Opportunity cost: Other job$30,000 Best investment alternative $400,000 x 0.08$32,000 Total opportunity cost$62,000

Example: Determining Economic Profit Total accounting profit$110,000 - Total opportunity cost$62,000 = Economic profit$48,000

Demand: The Buyer Side of the Market Demand: the quantity that buyers are willing and able to buy in the market at various prices

Figure 3-4 Demand Curve

Law of Diminishing Marginal Utility As more and more of a product is consumed, the extra satisfaction of consuming an additional unit declines Relates directly to the negative slope of the demand curve

Factors Causing Demand Curve to Shift 1.Income 2.Tastes and preferences 3.Expectations 4.Population 5.Price of substitutes or complements

Figure 3-5 Shift in Demand

Derived Demand Derived demand: based on the need for a product that is indirectly related to consumer demand Examples: fertilizer corn beef lumber houses tires cars

Supply: The Seller Side of the Market Supply: the quantities that sellers are willing and able to put on the market at different prices

Figure 3-1 Supply Curve

Factors Causing Supply Curve to Shift 1.Change in technology 2.Change in price of inputs 3.Weather 4.Change in price of other products that can be produced

Figure 3-2 Shift in Supply

Changes in Supply Change in supply = movement of the entire supply curve Change in quantity supplied = movement up or down a given supply curve (no shift in curve)

Short Run Supply vs. Long Run Supply Short-run: marginal costs (MC) must cover average variable costs (AVC) (short-run supply = MC > AVC) Long-run: marginal costs (MC) must cover average total costs (ATC – fixed and variable) (long-run supply = MC > ATC)

Figure 3-3 Average and Marginal Cost Curves

Price Discovery Price discovery: the process of determining the point of market equilibrium (quantity and price) where one price and quantity clear the market at a given point in time

Figure 3-6 Market Equilibrium

Figure 3-7 Change in Market Equilibrium

Elasticity Elasticity of demand: reflects the percentage change in the quantity demanded when the price changes by 1% Elasticity = % change in quantity demanded % change in price

Levels of Demand Elasticity | e | > 1.0Elastic: small change in price = large change in quantity demanded | e | = 1.0Unitary | e | < 1.0Inelastic: change in price = small change in quantity demanded

Example: Demand for Bluegrass Seed

Utility Utility (or value) is added to a product through the changes transforming a farm product into a product the consumer wants

Types of Utility Added 1.Form utility: transforming the products characteristics 2.Time utility: storage until product is needed 3.Place utility: physically moving product to the consumer 4.Possession utility: allowing the transfer of ownership

Economic Principles to Maximize Profits Choose output where marginal cost equals marginal revenue: MC = MR Marginal cost: the additional cost incurred from producing 1 more unit of output Marginal revenue: the additional revenue generated by producing 1 more unit of output

Example: Riverside Orchard Input versus Output Beehives (input) Apples (bu) (output)

Example: Riverside Orchard Costs and Revenues Bee Hives (Input) (1) Bu. of Apples (Output) (2) Total Var. Cost (3) Total Fixed Cost (4) Total Cost (5) Mgl. Cost (6) Total Rev. (7) Mgl. Rev. (8) Prof. (9) 0200$ 0$1, $1, $ ,0001,030$1.501,320$ ,0001, , ,0001, , ,0001, , ,0001, ,

Example: Riverside Orchard Terms Total variable cost (3) = $30/hive Total fixed cost (4) = $1000 Total cost (5) = variable cost (3) + fixed cost (4)

Example: Riverside Orchard Terms Marginal cost (6) = change in total cost change in output Total revenue (7) = # units sold (2) x selling price ($6/bu)

Example: Riverside Orchard Terms Marginal revenue (8) = change in total revenue change in output Profit (9) = total revenue (7) – total cost (5)

Choose production were MC = MR In this case, where extra cost of producing one more bushel of apples is $5 and the value of that bushel is $6 3 hives and 234 bushels of apples Example: Riverside Orchard Decision

Economic Principles to Maximize Profits Choose a combination of inputs where the marginal rate of substitution equals the inverse price ratio: MRS = IPR

Example: Producing an 1,100- Pound Steer Curtis Brown wants to substitute more hay for corn in the feed ration

Example: Producing an 1,100- Pound Steer Hay (lbs)Corn (lbs)MRS Total ration cost 5001,300$ , , , , Assume the price of hay is 3 cents/lb and corn is 5 cents/lb

Example: Producing an 1,100- Pound Steer

To choose the least-cost ration, substitute hay for corn until MRS = IRP 700 lbs of hay and 1,125 pounds of corn MRS = 0.75 (as close as possible to IRP of 0.60 without being less)

Economic Principles to Maximize Profits Produce different products at levels where there are equal marginal returns

Example: Maximizing Sales by Allocating Hours Jane Henry, a salesperson, is deciding how many hours to allocate to each of her accounts in order to maximize her sales (time allocated in blocks of 5 hours)

Example: Maximizing Sales by Allocating Hours Sls Call Time (hrs) Taylor Brothers JJohnson Commercial Growers Schiek and Company Bailey Family Farms SalesMRSalesMRSalesMRSalesMR

Example: Maximizing Sales by Allocating Hours Allocate inputs according to equal marginal returns Allocate 5 hours of call time to the Taylor Brothers, Johnson Commercial Growers, and Schiek and Company accounts Allocate 15 hours to the Bailey Family Farms account

Marketing System Functions 1.Exchange functions: product must be bought and sold at least once 2.Physical functions: transportation, storage, processing 3.Facilitating functions: market information, risk bearing, standardization and grading, financing

Market System Efficiency 1.Operational efficiency: concerned with the physical activities of the marketing system OE = (Marketing output)/(Marketing input)

Market System Efficiency 2.Pricing efficiency: concerned with how effectively prices reflect the costs of moving output through the marketing system