Cost & Return Analysis

1. Cost & Return Analysis Ag Management Ch 5

2. Objectives • Describe inputs and outputs • Explain the principle of diminishing returns • Describe the 3 stages of the production function • Describe the amount of inputs that will return the maximum profit • Determine the opportunity cost

3. Input-Output Relationships

4. Inputs • Materials that determine fixed and variable costs

5. Outputs • The different results of varying the amount of input used in production

6. Relationship of Inputs & Outputs • The basic relationship that allows analysis of an input and an output is called a production function • See Example p. 5-2 to 5-4

7. Principle of Diminishing Returns • As an input is added in production, the output will increase at an increasing rate then at a decreasing rate and finally decline • Fig 1 p. 5-4

8. 3 Ways of Measuring Production • Total Product (TP) • The production (output) that can be achieved with the various levels of input. • Example: We apply one unit of fertilizer and we get an amount of output, when plotted this gives the TP curve. • Average Product (AP) • Total Product/Amount of Input • Marginal Product (MP) • Change in total product for a change in input • Examples- Table 2 Columns 1-4 p. 5-5

9. 3 Stages of Production Function • An increasing average return for each added unit of input. • Average product (AP)= Total Yield (TP)/ the Number of Units of the Variable Input • Begins when Marginal Product (MP)=Average Product (AP) • Diminishing returns begin to develop in Stage 2 • Begins when Marginal Product (MP) becomes 0. • In this stage the total product actually decreases if the input increases.

10. Profit Maximizing Rule • Maximum profit will be obtained if you add the variable input to the point where the value of the marginal product (VMP) equals the price of the added input • VMP=Price of Input • VMP is found by multiplying Marginal Product (MP) by the price of the product • MP x Price of Product= VMP

11. Opportunity Costs • The cost of using a resource one way based on the return that could be obtained from using it in the best alternative way. • Example: p. 5-6

12. Input-Input Relationship

13. Why Input-Input Relationships are Used • Inputs have individual and combined impacts on the final product

14. Methods of Determining Least Cost Ration Formula • Graphics • Mathematical • p. 5-9

15. “Same Production” Line • Used in the graphical least cost ration method • Occurs when all points are connected into a line segment • Fig 4 p. 5-9—the line shows the combination of soybean oil meal and corn for 100 pounds of gain for 60 lb hogs

16. “Same Cost” Line • Take a given amount of money and divide by the cost per pound of a feedstuff to get the quantity of feed that amount of money will purchase. Do the same for other feedstuffs, connect points A and B and this is the same cost line • See p. 5-9 , 5-10 (fig 6)

17. Least Cost Ration • Found by moving the same cost line parallel to itself until it touches the same production line at one point only. • Point C fig 6 p. 5-10 • Mathematical Formula Change in Feed A/Change in Feed B= Price of Feed B/Price of Feed A

18. Math Method Steps • Determine the rate that one input substitutes for another. This is the marginal rate of substitution. • Compute the price ration. This should be the price at the point of use. • Find the ration for which the two rations are equal. This is the least-cost combination of the two inputs.

19. Break-Even Analysis • Can provide price and/or yield targets that can be beneficial in planning

20. Risk Management Analysis • When used in enterprise budgets can be useful when completing the financial analysis • Table 3/Table C---Crop Insurance

21. Summary & Assignment* • Summary p. 5-12 • Assignment complete review questions 1-9.