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Discussion Outline
• How can precision agriculture be used?
• Output-Output Model
• Partial Budgeting
• Break-even Analysis
• CRP Enrollment
Learning Outcomes
• You should be able to develop and apply a produce/don’t produce decision rule
• Develop and apply a CRP enrollment decision rule (or other payment type)
• Display comprehension of the economic theory of enterprise selection
• Use a partial budget
Tactical Decisions
• Seasonal or short run aspects
• VRT - variable rate technology
• Grid sampling
• Crop mix
• Production practices (planting date, seeding rate, variety, etc.)
• Others
Strategic Decisions
• Multiple year, long run decisions
• CRP (Conservation Reserve Program) enrollment and similar
• Possibly - produce or not
• Purchase of PA equipment
• Land purchase or improvements
• Others
Output Substitution
• Answers the question “What should I produce?”
• Examples - corn or soybeans, cattle or hogs, CRP or commodity
• What are the three steps in applying economic production decision rules? - physical data, economic data, apply rule
Production Possibility Curve
• Physical relationship
• Also production possibility frontier
• Shows all possible output (enterprise) combinations for a given set of inputs
• MRT - Marginal Rate of Transformation, the slope of the PPC, the rate at which one output can replace another
Output Ratios
• Output substitution ratio = Y1 / Y2
• Amount of Lost Output /Amount of Gained Output
• Output price ratio = Py2/Py1
• Price of Output Gained/Price of Output Lost
Profit Maximizing Enterprise Combination Rule
Y1/Y2 = Py2/Py1
• Gross Revenue = Py1Y1 + Py2Y2
• GR - Py2Y2=Py1Y1
• GR/Py1 - Py2/Py1Y2 = Y1
• The additional revenue from production are equal across all outputs for profit maximization
Slopes
• Slope of PPC is MRT
• Slope of gross revenue is output price ratio
• The tangency point is where the two slopes are equal which gives the maximum revenue
Output Substitution WorksheetPy2 = 1 Py1 = 3
Enter.Mix Y2 Y1
OutputSubs.Ratio
OutputPriceRatio
Valueof
Prod.A 0 500 NA NA 1500
B 150 450 0.33 0.33 1500
C 300 300 1.00 0.33 1200
D 450 0 2.00 0.33 450
Partial Budget
• Answers “Should I make a change?”
• Can include output-output model
• Estimate of changes in income, expenses and profits associated with a proposed modification in the whole farm plan
• Examples of possible changes?
Partial Budget Aspects
• Allows managers to make adjustments
• “Fine-tuning”
• Consider interactions consciously
• Focus on marginal - things that actually change from implementing the new plan
• If it doesn’t change, don’t include it
Four Things Can Happen as a Part of a Change:
• Additional Revenue
• Reduced Revenue
• Additional Costs
• Reduced Costs
• Additional revenue and reduced costs raise profits
• Reduced revenue and additional costs lowers profits
Partial Budget Advantages
• Enterprise substitution (PPC), input substitution (isoquant), level (production function) or size/scale of operation (all 3)
• Simplifies task involving complex decisions
• Forces consideration of marginal economics
• Encourages considering change -simple tool
Partial Budget Disadvantages
• Can still be cumbersome with complex changes
• Economic evaluation not always a physically feasible evaluation
• Many small changes are possible but not enough time to evaluate them all with partial budgeting
Partial Budget Example - Stop Production on Marginal Land
Add. Costs : Add. Rev. : None 0 None 0
Red. Rev. : Red. Costs: Corn sales 210 Var. costs 180 Total AC+RR 210 Total AR+RC 180 (AR+RC) - (AC+RR)= -$30
Partial Budget Example - Enroll in CRP
Add. Costs : Add. Rev. : Establishmentand Maint.
5 CRP payment 150
Red. Rev. : Red. Costs: Corn sales 210 Var. costs 180 Total AC+RR 215 Total AR+RC 330 (AR+RC) - (AC+RR)= +$115
Considerations
• Economies of size (e.g. 20% increase in size may not increase labor 20%)
• Opportunity cost (e.g. leisure time value)
• Risks should be reflected (up/down)
• Feasibility (physically possible, resource requirements)
• Desirability (noneconomic goals)
To Produce or Not, That is the Question
• Example of big potential gains in strategic decisions
• If you don’t cover your operating costs, don’t produce
• Yield maps highlighting less than break-even point
Break-even Analysis for CRP Enrollment Example
• (AR+RC) - (AC+RR) = 0
• (CRP + VC) - (EST + MAINT + P*Y) = 0
• P*Y = CRP + VC - EST - MAINT
• Y = (CRP + VC - EST - MAINT)/P
CRP Enrollment Example
• Lower producing, qualifying areas of the field
• Similar to produce or not
• Depends on whether owned land, cash rent or crop share
• Reduced risk should be considered
• Decision aid being developed
Other Factors
• Land tenure arrangement - owned, cash rent, crop share, cost share
• Willingness and ability to bear risk - CRP is a constant payment versus uncertain yield level