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
Susan’s accounting profit:

Net income of business $75,000

Salary withdrawal $35,000
Total accounting profit $110,000
Example:
Determining Economic Profit
Alternative uses for Susan’s
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
D1
40

30

20
Price ($)

10

0 100 200 300 400 500 600

Quantity (units)
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
D1 D2

40
Price ($)

30

20

10

0 100 200 300 400 500 600

Quantity (units)
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

40
Price ($)

30

20

10

0
0 100 200 300 400 500 600 700

Quantity (units)
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
S1

40
S2
Price ($)

30

20

10

0 100 200 300 400 500 600 700

Quantity (units)
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
Marginal and average costs ($/unit)

MC
40

MC > ATC
30

MC > AVC
20

AT C
10 A
AVC
T A
AFC
A
V
C
0 100 200 300 400 500 F
600
C 700
Quantity (units) C
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
D 2001
S
Price ($/tractor)

P 2001

Q 2001

Quantity
 Figure 3-7
Change in Market Equilibrium
D 2001 S

D 2002
Price ($/tractor)

P 2001

P 2002

Q 2002 QQ 2001

Quantity
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 | > 1.0 Elastic: small change in
price = large change
in quantity demanded
| e | = 1.0 Unitary
| e | < 1.0 Inelastic: change in
price = small change
in quantity demanded
Example: Demand for Bluegrass
Seed
50
0
40
Price ($)

30
20
10 D

0
0 100 200 300 400 500
00
Quantity (100 lb. units)
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
product’s 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 Apples (bu)
(input) (output)
0 200
1 220
2 228
3 234
4 237
5 236
 Example: Riverside Orchard
Costs and Revenues
Bee Bu. of Total Total
Hives Apples Var. Fixed Total Mgl. Total Mgl.
(Input) (Output) Cost Cost Cost Cost Rev. Rev. Prof.
(1) (2) (3) (4) (5) (6) (7) (8) (9)

0 200 $ 0 $1,000 $1,00 ---- $1,200 ---- $200

0
1 220 30 1,000 1,030 $1.50 1,320 $6.00 290

2 228 60 1,000 1,060 3.75 1,368 6.00 308

3 234 90 1,000 1,090 5.00 1,404 6.00 314

4 237 120 1,000 1,120 10.00 1,422 6.00 302

5 236 150 1,000 1,150 ---- 1,416 6.00 266

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
$30 − $0
= $1.50 / bushel
220 bushels - 200 bushels

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)
Example:
Riverside Orchard Decision
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

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
Total
Hay (lbs) Corn (lbs) MRS
ration cost
500 1,300 $80.00
600 1,200 1.00 78.00
700 1,125 .75 77.25
800 1,075 .50 77.75
900 1,050 .25 79.50
Assume the price of hay is 3 cents/lb and corn is 5 cents/lb
 Example: Producing an
1,100- Pound Steer

change in amount of corn

MRS hay for corn =
change in amount of hay

IPR = price of hay = $0.03/poun d = 0.60

price of corn $0.05/poun d
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
JJohnson
Call Taylor Schiek Bailey
Commercial
Time Brothers and Company Family Farms
Growers
(hrs)

Sales MR Sales MR Sales MR Sales MR

0 64 - 75 - 79 - 65 -
5 70 6 81 6 85 6 75 10
10 75 5 86 5 89 4 83 8
15 79 4 90 4 92 3 89 6
20 82 3 92 2 93 1 93 4
25 84 2 93 1 93 0 95 2
30 85 1 93 0 93 0 96 1
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