Download Introduction to Production and Resource Use

What is
Agricultural
Economics?
Chapter 1
Impact of reduced wheat supply
on world wheat prices in the U.S.
How can a value be placed on wildlife
not part of a commercial harvest?
What are the benefits vs. costs of
using the vaccine that could
prevent the spread of salmonella?
What are the
income and
employment
impacts on
other industries
and on
government
revenues?
Discussion Topics
Scope of economics
Definition of economics
Definition of agricultural economics
What do agricultural economists do?
General Overview
Agricultural economics studies agriculture
and the food industry in its many
dimensions
The agricultural economist is concerned
with the entire food and fiber system
Purchased and non-purchased inputs used
Production of primary product
Processing primary product into final product
Distribute final product to final consumption
point
Consumption of the final product
General Overview
Study of agricultural economics covers
much more than activities of farmers or
ranchers.
Some economists deal with issues of resource
conservation, pollution control, and water
management.
Others study the agribusiness sector as
purchasers, processors, and distributors of food
and fiber products.
General Overview
 Agricultural Economics a subfield of Applied
Economics
 Applied Economics: Application of
economic theory to actual events
 Examples of economic specialization: labor,
education, health, monetary, public, history,
environmental, renewable resources, nonrenewable resources, industrial organization, etc
 Typically involves a reduction in the level of
abstraction of core theory
 Depict actual characteristics of economic
problem of concern
General Overview
 The objective of any scientific inquiry
is to:
Observe and describe a particular set of
phenomena
Organize those observations into
recognizable patterns
Formulate theories or models where
sufficient regularity is sought
 Theory give scientist a basis on which to make
predictions
 i.e., theory of supply and demand
General Overview
Economics is a social science and social
scientists must deal with the laws of human
nature
 Humans are not consistent in their behavior
 → social science theory are less reliable than hard
science based (i.e., 2 molecules of hydrogen and 1
molecule of oxygen required for H20, water)
 → more open to exception than those of
physical/biological scientists.
 Nevertheless, economic behavior of most
persons is generally consistent, and thus,
predictable to some degree
 Certainty varies across phenomena
Definition of Economics
“…a social science concerned with
how consumers, producers, and
societies choose among alternative
competing uses of scarce resources
in the process of producing,
exchanging, and consuming goods
and services”
Page 5
Definition of Economics
The study of economics rests on three
foundations:
Self-interest
Scarcity and
Choice
Without scarcity, there would be no
need for an allocation system
Page 5
Definition of Economics
Choice is important because without
choices there is no decision to be made.
Since economics is about decision making,
allocation without choices → there would be
no need for economics or economists
Self-interest
Drives the consumer to purchase more at a
lower price
It also drives the producer to produce as
efficiently as possible to maximize profits
A majority of economic activity is driven by
self-interest
Page 5
Scarce Resources
Resources describes anything tangible
Wheat, barbed wire, hamburgers, water, labor,
clean air
Every resource is relatively scarce
→ availability of every resource is insufficient
to satisfy all of its potential users
Scarcity creates need for a system to
allocate resources among potential users
Need a theory by which allocation takes place
Pages 2-3
Scarce Resources
Natural and biological resources
3.5 million square miles of land surface in U.S.
954 million acres of land in farms in U.S.
Limited supply of crude oil/natural gas
reserves
Human resources
>155 million people in U.S. civilian labor force
Manufactured resources
3.9 million miles of highways
121.4 million tons of steel making capacity
Pages 2-3
Making Choices
Resource scarcity forces consumers and
producers to make choices
Opportunity cost – an implicit cost associated
with economic decisions often not reflected in
the market
Specialization – comparative advantage and the
basis for trade between countries
Individual decisions – maximization of
consumer utility and/or producer profits
Societal decisions – how can we impact
production possibilities given existing resources
(solar technology subsidies vs. carbon tax)
Pages 3-4
An Example of
Specialization
Specialization Example
Kansas
Surplus of Wheat
Shortage of Oranges
Shortage of Potatoes
Relative strengths of Kansas:
Strong in wheat production
Page 4
Specialization Example
Shortage of Wheat
Shortage of Oranges
Surplus of Potatoes
Idaho
Relative strengths of Idaho:
Strong in potato production
Page 4
Specialization Example
Florida
Shortage of Wheat
Surplus of Oranges
Shortage of Potatoes
Relative strengths of Florida:
Strong in orange production
Page 4
Specialization Example
 Surplus of Wheat
 Shortage of Oranges
 Shortage of Potatoes
Kansas
Florida
Potatoes
Idaho
 Shortage of Wheat
 Shortage of Oranges
 Surplus of Potatoes
Oranges
Each state specializes in what it does
best and trades with other states…
 Shortage of Wheat
 Surplus of Oranges
 Shortage of Potatoes
Page 4
Basis of Economics
Every economic system must resolve 5
basic issues
What to produce
How to produce it
How much to produce
When to produce
For whom to produce
Every society must answer the above
questions
Society’s institutional and political systems
determine the manner in which these
decisions are made
Basis of Economics
 One allocation mechanism lies in the free
market or price system
Individual producer and consumers,
restricted only by financial resources, are free
to choose what, how, how much, and when to
produce or consume.
 Financial resources of each consumer resolves the
“for whom” question
 Another mechanism is the command system
All decisions are made by a central planning
agency or individual
Pages 5-6
Basis of Economics
Advantage of the price system is consumer
sovereignty and freedom
The price system is an efficient mechanism
for what, how, how much, and when decisions
There are some shortcomings:
The old adage, that the rich get richer and the
poor get poorer, has some validity as there is no
consideration of income distribution
There are a number of resources that a price
system cannot efficiently allocate.
 Public or nonmarket goods (i.e., education, national
defense, fire protection, wilderness areas, clean air,
clean water, viable fish population, etc.)
Pages 5-6
Basis of Economics
Advantages of a command system are that
it is very effective in allocating public
goods
Can be quite egalitarian in for whom decisions
 Consider distributional effects
Disadvantage of command system is the
loss of individual freedom in economic
decisions
Inherent inefficiencies of central planning
agencies
Pages 5-6
Scope of Economics
Economics can be divided into three
parts:
Microeconomics
Market economics
Macroeconomics
Aggregation
levels differ
As the level of aggregation changes
economic tools may also change
What makes sense for decision-making by
the individual may not necessarily be valid
for a group or an entire economy
Pages 5-6
Scope of Economics
 Microeconomics concerned with the
economics of individual producers
and/or consumers
 The microeconomics of production
examines the economics of individual
producers or firms
 How does a firm acquire resources and
combine them in the production process?
 What is the difference between cost
minimization vs. profit maximization in
terms of resource use?
Pages 5-6
Scope of Economics
Production management decisions
impacting firm profit include:
Which inputs to purchase
 Multiple inputs to choose from (i.e., should I
rent cropland versus purchasing)
 Should this choice depend on input prices (i.e.,
what is the annual rental rate vs. ownership
costs)?
What production technique to use
 Multiple production technologies (i.e.,
conventional tillage, minimum tillage, no-till)
 Technology determines input utilization (i.e.,
no-till requires less energy inputs and water
use)
Pages 5-6
Scope of Economics
Production management decisions
impacting firm profit include:
Which product to produce
 Multiple products to choose from (i.e., how
much of my land to devote to corn vs.
soybeans)
How much of each product to produce
 Should this depend on product prices (i.e.,
corn costs more/acre to grow than soybeans)
When to produce them
Marginal benefit versus costs of waiting a week
to plant so that the soil is more dry
Economics of storage
Pages 5-6
Scope of Economics
Another branch of microeconomics
concerned with individual consumer
behavior
 Microeconomics of consumption
The consumer is faced with the
economic problem of deciding what to
purchase with limited resources
 Money and time are two such limited
resources
Pages 5-6
Scope of Economics
 The individual consumer must make a
number of consumption decisions
over time
 May not be the product of conscious
deliberation
 May be habitual or impulsive
 The consumer must decide what to buy
and what not to buy (i.e., full-fat vs.
reduced fat milk)
 Consumer must also decide when to
consume
 Purchase off-season at discounted prices
Pages 5-6
Scope of Economics
 Each consumer faces the inevitability
of scarcity in the form of a limited
budget
Given this scarcity, each consumer uses
his/her sovereignty to resolve the for
whom allocative decision
Pages 5-6
Scope of Economics
 A market is established when potential
buyers and sellers interact to negotiate
prices and exchange goods
 Market versus a marketplace
Market refers to interaction of buyers and
sellers
Marketplace refers to the physical
location where market participants
interact
Pages 5-6
Scope of Economics
Market economics encompasses the study
of the dealings in a particular commodity
 Interaction of all potential buyers and sellers
P*
Q*
Pages 5-6
Scope of Economics
In the neoclassical model of the market
Each participant in a market (buyer or
seller) is a price taker
 Collective decisions of all participants in a
market determine the price
 An individual consumer has no impact on
market price
Pages 5-6
Scope of Economics
As a price taker the only decision each
producer/consumer can make is a
choice of whether or not to sell/buy at
the market price
As the number of yes votes changes, in
aggregate, the price will also change
Pages 5-6
Scope of Economics
Four characteristics of a commodity
that are impacted by its marketing
 That is, moving the commodity from
point of production to final consumer
 Time
Place
Form
Possession
Pages 5-6
Scope of Economics
It is a complex system that transforms a
Kansas farmer’s August wheat harvest
to a New York stock broker’s toast in
January
Form of the wheat must be changed:
wheat kernels → wheat flour → bread
The place moves from KS to NY
Time changes from August to January
Possession changes from farmer to banker
Pages 5-6
Scope of Economics
Macroeconomics concerned with the
entire economic system
City, state, national or international level
Questions considered
 What are the linkages within the
economic system as a whole?
 What are the economy-wide impacts of
changes in policies or institutions?
 What impacts the unemployment and
inflation rates, the balance of payments,
and the Federal deficit?
Pages 5-6
Scope of Economics
Macroeconomics Example
Pages 5-6
Scope of Economics
 Economic system performance at the
macro level is important to
agricultural producers and consumers
 Micro management decisions are
predicated on existing macro-economic
conditions
 i.e., the Federal Reserve guaranteed low
interest rates for the next two years.
 Cheese plant manager: Do I expand my
cheese plant given these low interest rates?
 With 15 year mortgages @ 3.5% should I
refinance?
Pages 5-6
Scope of Economics
 Macroeconomics deals with the
economic impacts of public policies
 Food stamps, pesticide use restrictions,
dairy product price support system, etc.
 These policies can impact a particular
sector of the economy as well as the the
entire economy
 The macroeconomist also concerned
with international issues
Pages 5-6
Scope of Economics
U.S. agricultural sector: International
markets are increasingly important
Foreign buyers are one of the most
important market for U.S. crop
production
 40% of cropland used to produce food & fiber
that is exported
Other sectors becoming increasingly
dependent on foreign export markets
 Productivity growth rate higher than domestic
demand expansion.
Pages 5-6
Scope of Economics
% of Dairy
Solids
14.5
U.S. Exports and Imports as a Percent of Total
U.S. Milk Solids Production
Dramatic Drop
In Milk Prices
13.0
11.5
10.0
Dairy Exports
8.5
7.0
5.5
Dairy Imports
4.0
2.5
Pages 5-6
Scope of Economics
U.S. agricultural sector: International
markets are increasingly important
Imports—particularly petroleum—are
important in the cost structure of U.S.
farmers, food processors, and distributors
We share a humanitarian concern for
world’s population that lives in hunger
Pages 5-6
Scope of Economics
Pages 5-6
What is Agricultural
Economics?
“…an applied social science that deals
with how producers, consumers, and
societies use scarce resources in the
production, processing, marketing, and
consumption of food and fiber products”
Page 6
Economic Models
Economists like to abstract from the
complexity of the real world via the use
economic models
 Simplification of and abstraction from
observed data
Model of Market
Supply and Demand
• Market clearing price
• Market clearing quantity
P′
P*
Q1
Q2
Q*
Economic Models
An economic model
 Is a theoretical construct developed via
logical reasoning
 Represents economic processes and include
 Variables that describe the system
 Logical and/or quantitative relationships
between these variables
• i.e., Unemployment rate and mortgage lending rates
 Simplified framework used to illustrate
complex processes
 Sometimes, but not always, based on
mathematical techniques
Economic Models
Simplification is important for economic
models given enormous complexity of
economic processes
Complexity arises from diversity of
factors determining economic activity
 Individual/cooperative decision making
 Resource limitations
 Environmental & geographical constraints
 Institutional and legal requirements
 Purely random fluctuations (i.e. weather)
Economic Models
When developing an economic model the
economist must make a reasoned choice:
 Which variables are relevant
 Which relationships between these
variables are relevant
 Which ways of analyzing and presenting
this information are useful
 i.e., model type/structure
Economic Models
Economic models when properly
constructed
 Remove extraneous information
 Isolate useful approximations of key
relationships
 More can be understood about
relationships in question than by trying
to understand entire economic process
Economic Models
A common economic model: Perfect
Competition → a number of
assumptions about the firm and its
environment
 The firm is small relative to the market
and its actions will not impact the market
 Firm manager tries to maximize profits
given resource endowment
Are the assumptions valid?
 If not, model results may not be valid
Economic Models
Ideally, economic models approximate
reality in a manner that enhances ones
ability to conceptualize and
understand real world events
Models provide the economist with an
internally consistent mechanism for
conceptualizing problems
They force the economist to reason in a
systematic, logical and deductive manner
Ceteris Paribus
Ceteris paribus: is a Latin phrase
that roughly translates: everything
else being equal
An economic principle is valid only when
all other external factors remain the
same
 i.e., Impact of a price change on sales given
income does not change
Use of ceteris paribus gives economics
much of the logical rigor required in a
scientific inquiry
Opportunity Cost
Opportunity cost: Important term
All economic resources have value
 Value usually determined in a marketplace
where resource user pays prevailing price
 Sometimes resources have economic value
but those resources not purchased in a
market
 In this last case economists use
opportunity costs to determine the
resource’s economic value
 Though there is no market price
Opportunity Cost
Opportunity cost is the economic
value of a resource in its highest
valued alternative use
Opportunity Cost
Opportunity cost of a choice is what
you gave up to get it
Choose between purchasing either an
apple or an orange
If you choose the apple, then your
opportunity cost is the orange you could
have chosen but didn't.
You gave up the opportunity to take the
orange in order to choose the apple
Opportunity Cost
Common mistake: Price vs. Cost
Price is a per-unit concept
 i.e., What is the price of a gallon of gasoline?
Cost refers to the concept of prices times
quantity purchased
 i.e., What did it cost to fill up your car?
Opportunity Cost
The study of economics is all about
economic values—costs vs. returns
 When available, we use market prices
to determine economic value.
 When market prices are not available,
we use the concept of opportunity cost
to estimate those values
 Returns can be measured in terms of $
or in terms of satisfaction (or utility)
Diminishing Returns
In models of the economics of
production and consumption the
concept of diminishing returns is key
As you increase the amount of something,
ceteris paribus, you will eventually reach a
point where you increase at a decreasing
rate
 i.e., A diminishing increase in corn yield with
respect to increasing amount of applied
fertilizer
Diminishing Returns
Consumer side: Law of diminishing
marginal utility
Marginal utility: The additional utility
(satisfaction) associated with one
additional unit of a good being
consumed—ceteris paribus
→ Amount of utility gained from
consuming a good eventually increases
but at a decreasing rate
 Assuming consumption of everything else
stays constant
Diminishing Returns
Production side: Law of diminishing
marginal product
If you add a certain level of an input to
fixed amounts of other inputs, the
additional production from this extra
input will eventually decrease
 i.e., If you add additional units of fertilizer
to a fixed amount of land, eventually
response per unit of fertilizer continues to
increase but at a decreasing rate
Can eventually turn negative
 Too much fertilizer can burn a crop, ↓yield
Diminishing Returns
Source: Yates, F. & Boyd, D. A. (1949). Agric. Progr. 24, 14.
S.E. = starch equivalent
Marginality
One of the greatest contributions of
economics is the concept of
marginality
 Marginal refers to an additional or
incremental unit of something
Most economic analyses deal not with
marginal value of production or
consumption
 However, it is on the margin where the
economic decisions are made
Marginality
The consumer’s relevant economic
question:
 Is the marginal utility associated with
purchasing an additional unit of a good
greater than the marginal cost of
acquiring that additional unit?
Marginality
Regardless of current total
satisfaction (utility) level
If the marginal utility is greater than the
marginal cost → the consumer can
increase total utility by consuming this
marginal unit as benefit > cost
The same basic principle applies to
production
If marginal value of output is greater
than the marginal cost of production then
produce that marginal unit
Marginality
↓ Marginal returns (MR) per lb of fertilizer
as application rate ↑, ceteris paribus
Marginal Costs and Returns
$/lb fert.
A
Marginal cost (MC) of obtaining
additional fertilizer is constant and equals
fertilizer price
0.20
0.15
B
Economical input use
occurs at the margin
0.10
C
Q1
Q2
Q3
Quantity of Fertilizer/Acre
Between A & B:
Cost/lb of fert. < MR → ↑ fert. use
Between B & C:
Cost/lb of fert. > MR → ↓ fert. use
Marginality
Using marginal analyses one can
determine the behavior that will
maximze profit, minimize cost,
maximize utility or maximize social
welfare
One can ignore total costs or returns
Concentrating only on marginal costs
and returns
From the economist’s perspective,
everything happens on the margin
Logical Fallacies
Many economists go astray because
they fall into one of four logical traps
Known to snare large numbers of
agricultural economics students
I have fallen into some of these
The Four Traps
Correlation-Causation
Composition
Post Hoc
Zero-Sum Game
Logical Fallacies
Correlation-Causation Fallacy
Correlation refers to two events that
share some sort of mutual relationship in
a regular and predictable manner
Causation refers to two events in which
there is a cause-and-effect relationship
between two events
Logical Fallacies
 When two events have a causal
relationship, they also have a correlation
 Fallacy is assuming that if two events
are correlated they must be related in
some sort of causative manner
 Frequently, events that are correlated
behave in a mutual relationship because
they are both related in a causative
fashion to some 3rd event
Logical Fallacies
 Zero-Sum Game Fallacy
 Common in economics: If someone gains,
someone else must lose
 This is the heart of the nearly universal
suspicion that both producers and
consumers are repeatedly exploited by
“middlemen”
 Often expressed by the question: Who got
the better part of the deal?
Logical Fallacies
 The basis of economics is exchange
Usually a good/service exchanged for $
 A skeptic: In a transaction the buyer
and seller are equally worse off
To the contrary, both are better off, for
each has acquired something he wanted
more than what he had
 If they weren’t better off they would never
have traded in the first place
Logical Fallacies
A completed economic transaction
with no coercion is a win–win
situation
Rather than a win–lose situation as
suggested by this fallacy
As a result of the exchange, perceived
value controlled by each is increased
Fact, Beliefs and Values
 Economics is concerned with the
value system of individuals and
society
 Important to distinguish between
facts, beliefs and values
Facts are what we know to be the case
Beliefs are what we think to be the case
Values are what we think should be the
case
In Summary
Resource scarcity - natural, human
and manufactured – forces
individuals and societies to make
choices
Comparative advantage leads to
trade
Micro vs. Macroeconomics
Reviewed scope of economics
Definition of agricultural economics
Chapter 2 presents an overview
of the U.S. food and fiber
industry…