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Economics of Production


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Title: Economics of Production

Economics of Production
  • Today we will discuss how input-output
    relationships are necessary to understanding
    problems with resource allocation.
  • Advances in technology change aquaculture
    production constantly.
  • No product is produced with a single input

Production Economics
  • Economics of production is really microeconomics
    applied to aquaculture in our case.
  • Studying production principles should clarify
    issues such as costs, output response to input,
    and the use of resources to maximize
    profit/minimize costs
  • A multi-disciplinary approach is necessary to
    truly appreciate production economics.
  • Developed from agronomists considering more than
    the biology of production

Production Economics Questions
  • What is efficient production?
  • How do we determine the most
  • profitable amount of input?
  • How will change in output price influence
  • How do we maximize farm profits through
    utilization of different enterprises?
  • How much should you pay for a pump?
  • Is technology beneficial to production output?

Production Economicscomplexity
  • Crops grow seasonally and are affected by
    numerous inputs
  • Some inputs we control, others are random e.g.,
  • Time is also important (e.g. differences in
    production cycles)
  • Can we cope?

Economics and Production Complexity
  • All the variables you manipulate (i.e. rates of
    fertilizer, stocking densities, feed, feed
    ingredient level, aeration, etc.) affect your
    response (yield)
  • When we compile multiple years of data from these
    changes, we can predict the response in a similar
    vein to what economist do.
  • However, aquaculture research and production
    lives in the here and now, economists are not
    experimental and use only existing data
  • Key difference economists manipulate nothing.
    They simply look at what conditions were in
    effect when a previous production cycle occurred.

Production Theory Classification of Inputs
  • Manager has control over variable inputs such as
    rate of fertilization, feed rate, etc.
  • What we dont control is called fixed input,
    unchanging during length of trial (harvesting
    pump feed silos, vehicles, land)
  • Random inputs associated with nature or
    economics beyond that of the farm
  • All this results in unique growing seasons.

Production Theory Assumptions that make it work
  1. Factors are continuous for entire production
    cycle (e.g., level of technology, land ownership,
    govt. programs)
  2. Production curve is smooth, well-behaved (e.g.,
    fertilizer, labor is a bad ex.)
  3. The manager has perfect insight (perfect
  4. No time discounting of production, or discount
    in price for early payment of a bill (removes
    time element from consideration)
  5. Manager is motivated by profits and optimization

Production Theory Assumptions
  • Assumpitons are used to simplify the analysis to
    a point where a reasonable starting point can be
    identified, not to discount real world events.
  • Example following one experiment, to work with
    a wider stocking density, over more years
  • After the elementary theory has been developed,
    each additional source of complexity can be

Goals of Production Economics
  • assist farm managers in determining the best use
    of resources, given changing needs, values and
    goals of society
  • assist policy makers in determining the
    consequences of alternative public policies on
    output, profits, and use of resources on the farm
  • evaluate the uses of the theory of the firm for
    improving farm management and understanding the
    behavior of the farm as a profit-maximizing

Goals of Production Economics (continued)
  1. evaluate the effects of technical and
    institutional changes on aquaculture production
    and resource use
  2. determine individual farm and aggregated regional
    farm adjustments to output supply and resource
    use to changes in economic variables in the

How it works
  • The effect of a single input on output can be
    determined if only that input is varied and all
    others are held constant.
  • Involves
  • concept of the production function
  • average and marginal physical product
  • various stages of production

Concept of a Production Function
  • The production function represents an
    input-output relationship
  • describes the rate at which resources are
    transformed into products
  • relationships vary animal variety, soil types,
    water quality, technologies, El Niño
  • any given input-output relationship specifies the
    quantities and qualities of resources needed to
    produce a particular product

The Production Function
  • The function can be expressed in many ways
    written form, tabular, graphical
  • written form Y f(X1, X2, X3,, Xn)
  • Y output or yield, the Xs are different inputs
    that take part in the production of Y
  • examples yield is a function of stocking
    density, feed rate
  • Note this written equation/form does not
    specify the importance or contribution of inputs
    to the production process

The Production Function
  • The production function can also be shown in
    either tabular or graphical form
  • Usually picks one variable input and studies the
    effect on yield
  • Yield is also referred to as total physical
    product or TPP
  • Keeps all other variable inputs fixed as well
    as traditional fixed inputs
  • lets look at an example

Empirical Example
  • Fertilizer Yield
  • 0 lbs/ha 0 lbs
  • 20 37
  • 40 139
  • 60 288
  • 80 469
  • 100 667
  • 120 864
  • 140 1045
  • 160 1195
  • 180 1296
  • 200 1333
  • 220 1291

TPP curve
Tabular form
Graphical form
Empirical Example
  • Data in the previous table/figure represent a
    production function relating shrimp yields to
    applied fertilizer
  • units of fertilizer (e.g., nitrogen and
    phosphate) represent the variable input, while
    all other inputs needed to produce shrimp (seed,
    labor, fuel, land) are the fixed inputs
  • But hey, I thought fuel, seed, etc. were variable
    inputs! Typically, yes, but in this case they
    remain constant
  • As shown, large increases in yield result from
    initial fertilizer applications

Empirical Example
  • However, yield increases become smaller at higher
    levels of application
  • A max of 1,330 lbs/ha was achieved with 200 lbs
    of fertilizer, afterwards declining
  • Zero yield with zero input, in reality, is
    uncommon however, due to infertility of incoming
    water, soil, etc.
  • Note Although farmers dont typically use these
    functions, as such, they have mental pictures of
    what would happen, based on experience

More detail on the Classical Production Function
  • Other characteristics of production function
  • the production function is a continuous curve
  • inputs and outputs are perfectly divisible
    (otherwise, it would look like a series of dots)
  • inputs and outputs are homogenous (prices of
    product at one level of input are similar to

Total physical product (TPP) Curve
Production Assumptions (1) Perfect Certainty
  • To use the production function, economists,
    farmers, etc. must agree upon the outcome (yield)
    for each unit of input
  • past results (e.g. shrimp yields in response to
    fertilizer) must at least approximate this years
    function (perfect certainty)
  • thus, the production function is a planning device

Perfect Certainty
  • Knowing how inputs will perform is difficult year
    to year in new industries such as aquaculture
  • It helps if you are reasonably sure and on top of
  • This is one of the big differences between
    standard agriculture and aquaculture
  • In aquaculture, no two sites are the same
    inputs often function differently from one site
    to the next
  • Reality care must be given to select the
    appropriate production function
  • select the right one or suffer the consequences

Production Assumption 2 level of technology
  • If you produce, it is assumed that you do it via
    a certain methodology or process
  • unfortunately, a product can be produced in many
  • we normally assume in production economics that
    the manager uses the most up-to-date technology
  • Translation we assume the farmer uses the
    process that yields the most output from a given
    amount of input

Production Assumption 3 length of time period
  • The production function shows output at various
    levels of input over a specific length of time
  • As a result, all inputs (except the one youre
    evaluating ) are fixed
  • reasons for fixing a variable
  • maybe the amount used is just the right amount,
    any more or less would lower profits
  • maybe the production time period is too short to
    change the amount of resource on hand (e.g.,
  • the farmer just may not want to change the amount
    of resource (e.g., not changing the number of
    dairy cattle in order to evaluate a feed effect)

How to Work with the Production Function
  • There are several classical production functions
    for various agricultural situations
  • a discussion of all the production functions that
    now exist in agriculture would involve more space
    than any book could provide
  • Problem few are reported for aquaculture
  • it would be impossible to record them all as they
  • we are simply trying to gain a better
    understanding of input-output relations
  • the following are general guidelines and
    indications useful to farm managers

Three Stages of Production
  • The classical production function can be divided
    into three stages
  • First Stage the average rate at which variable
    input (X) is transformed into product (Y)
    increases until it reaches its maximum (i.e., Y/X
    is at its maximum)
  • this maximum indicates the end of Stage 1

Production Stage 1
  • Stage 1 deals with increasing bang for your buck
    or the phase of increasing production efficiency
  • production efficiency is not just the maximum
    production level
  • This efficiency is known as average physical
    product, APP and is determined by dividing yield
    by its corresponding amount of input (Y/X)
  • Stage 1 ends where Y/X is largest, around 150 lbs

Production Efficiency
Three Stages of Production
  • Stage 2 physical efficiency of the variable
    input is at a peak at the beginning of Stage 2
  • Stage 2 ends when yield (APP) is at its maximum
  • Bottom line maximum efficiciency does not equal
    maximum production

APP curve
TPP curve
Three Stages of Production
  • Stage 3 starts once TPP starts to decline
  • result of excessive quantities of variable input
    combined with fixed inputs
  • in order for all this to make sense, we need to
    understand that production functions are used to
    determine the most profitable amount of variable
    input and output
  • the production function allows you to make
    recommendations about input use even when
    input/output prices are unknown

What this Describes Law of Diminishing Returns
  • Originally developed by early economists to
    describe the relationship between output and a
    variable input, when other inputs are constant
  • if increasing the amount of one input is added to
    a production process while all others are
    constant, additional output will eventually
  • implies there is a right level of variable
    input to use with the combination of fixed inputs

Law of Diminishing Returns
  • Requires that the method of production does not
    change as variable input changes
  • does not apply when all inputs are varied
  • when the LDR is applied to production you get the
    classical production function
  • increasing marginal returns at first and
    decreasing marginal returns afterwards
  • it is possible that marginal returns could
    decrease in the beginning with the first
    application of the variable input

Economic Recommendations
  • 1) using logic you can see that if your
    production follows that of the example given, you
    should increase inputs to achieve a production
    level at least until Stage 2 is reached
  • it doesnt make sense to stop increasing input if
    its efficiency is increasing
  • 2) even if inputs are free, you dont want to be
    in Stage 3
  • the largest amount of input you would use is that
    at the end of Stage 2
  • the area of economic relevance is within Stage 2
    for firms that buy and sell in competitive
  • fine tuning comes from knowing prices

Homework 3 due next time
1) Develop a production curve using the following
data Stocking (fry/ac) Harvest Biomass
(lb/ha) 0 0 1,000 185 2,000 695 3,00
0 1,440 4,000 2,345 5,000 3,335 6,000
4,320 7,000 5,225 8,000 5,975 9,000
6,480 10,000 6,665 11,000 6455 2) At what
level of input would Stage 2 start?
Next Time Supply and Demand Relationships
(Seperich et al., 1994)
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