Product- Product Relationship

•Also called output- output relationship.

•Deals with what to produce? What combination of enterprise should be produce?
•Various enterprises are generally related to each other in terms of use and availability of resources.
• Some may help each other whether as some may hinder to each other in production.
•For instance, livestock either for meat or wool or dairy animal provide farm yard manure that is useful for crop
production and farm help livestock by providing feed and fodder at cheaper rate.
•On the other hand, cotton and wheat crops are competitive in terms of soil fertility.
•However every relationship of output will be competitive in long run.
•Algebraically , Y1= f (Y2, Y3, Y4, ……Yn)
•Suppose a farmer has 10 hectares of land and he wants to grow wheat along with other competitive crops like
gram, barley, sugarcane, fodder etc. In this case, acreage under wheat will be a function of acreage under gram,
barley, sugarcane and fodders.
•Although problems of use of inputs are important in decision making process in agriculture, yet more common
problems revolve around decisions on enterprise combination.
•As the farm resources available with the cultivators are limited and there are various alternatives farm
enterprises such as crops and livestock, the cultivator is generally faced with the question: what to produce and
with what technology? The problem is what combination of enterprise should be produced?
Marginal rate of product substitution (MRPS)
• It means the rate of change in quantity of one output as a result of unit increase in the other output, given that
the amount of the input used remains constant.
• The MRPS of Y1 to Y2 will be: MRPS = ΔY2 / ΔY1
Production possibility curve
• Production possibility curve presents all possible combinations of two products that could be produced with
given amounts of inputs.
• Production possibility curves are sometimes called opportunity curves or iso-resource curves.
• Term opportunity curve is used because the curve presents all possible production opportunities.
• It is known as iso-resource curve because each output combination on this curve has same resource
requirements.
• A change in technology or level of fixed inputs will cause a shift in production possibility curve.
• Suppose for 10 hectares of land (X) can be used to produce two products cotton (Y1) and maize (Y2);
assuming, all other inputs used to produce Y2 orY1are highly specialized and fixed.
• The farm manager has to decide, how much of input X to use on each product. If only 10 hectares of land are
available to the producer for the production of cotton and maize, we can determine various combinations of
the two products in such a manner that a maximum of one is obtained for any level of the other.
•If all 10 ha of land are used in the production of maize, we obtain 120 qtls of maize and do not get any
cotton.
• We can shift 1ha of land to the production of cotton. Then we get 8 qtls of cotton from 1ha and 108 qtls of
maize from 9 ha.
Basic Product Relationships
a. Joint products
• Products which result from the same production process are termed as joint products. No substitution
among products is possible since joint products are produced in a fixed proportion.
• Eg: cotton lint and cotton seed, wheat and straw, rice and straw, mutton and wool and cattle and manure.
• In these cases quantity of one product produced decides the quantity of the other product.
• Joint product are combined product- production of one without other is not possible.
• For production decisions, joint products can be treated as one product.
b. Complementary product
• Two products (or enterprises) are complementary if change in level of output of one product (Y1) also causes an
change in the output of other product (Y2) in same direction, for the same level of inputs.
• Example-Maize after barseem, Crop and livestock enterprises where livestock provides FYM and crop provides
straw, grasses and livestock.
• PPC for complementary products have positive slope.
• Complementary relationship exist between 2 products only up to certain level of production.
• In below figure, up to M to N and H to K complementary relationship holds but from N to K, products become
competitive.
• Marginal rate of product substitution between these two products in positive in complementary range.
• When two products are complementary, both enterprises should be produced up to the end of complementarity
stage without reference to price of two product.
Supplementary product
• Supplementary relationship between two enterprises exist if increase or decrease in the level of one product
does not affect the production level of other product.
• These product does not compete with each other, rather adds to total income of the farm.
• Example is of wheat and maize crops in relation to land, poultry, dairy and bee keeping enterprises.
• All supplementary relationships should be taken advantage of by producing both products to the point where the
products become competitive.
• A to B and C to D represent supplementary relationship.
d. Competitive products
• Two products (or enterprises) are competitive when an increase or decrease in production of one product affects
the production of other product inversely.
• Outputs are competitive because they require the same inputs at the same time.
• Competitive enterprises compete for farm resources & substitute for each other.
• Use of resource to produce more of one product necessitates a sacrifice in the quantity of other product.
• MRPS between products is negative. When two products are competitive, they may substitute at constant rate,
increasing rate or decreasing rate.
i. Constant Rate of Substitution:
• It means that a unit change in one product is throughout accompanied by the same unit opposite change in the
other product e.g. wheat & gram for land.
Y21 Y22 Y
•   ........  2 n
Y11 Y12 Y1n

• This is normally a short run relationship and over a longer period of time, constant marginal rate of substitution
between 2 products do not hold. When this relationship exists, it will be economical to produce only one of the
products depending upon the relative prices.
Y1Y2
Fig: Competitive products substitute at constant rate
ii. Increasing rate of substitution
• If this relationship holds true, each unit increase in the level of one product is accompanied by larger and
larger decrease in the level of the other product or vise varsa.
• For example, wheat and gram will substitute at an increasing rate for capital and labor.
• When wheat acreage is increased, there would be greater and greater need to be decrease gram acreage in
order to release capital and labor.
• In this case, maximum profits are made where slope of the production possibility curve is equal to the slope of
the price line.
 Y  Y  Y
• 21
 22
 .......  2 n
 Y 11  Y 12  Y 1 n
• Increasing rate of the product substitution is common
in agricultural production.
iii. Decreasing rate of substitution
• A unit increase in the level of one product in this case is accompanied by lesser by lesser decrease in the level
of another product.
• Dairy and crops within a limited range may substitute at decreasing rate.
• If this relationship holds, it will be economical to produce only one of the products.
• A combination of two products will never give highest returns, as each unit increase in one product will
require sacrifice of smaller quantity of the other product.
• Price line will be tangent at only one of the end points of the curve.
• This type of relationships are very rare in agricultural business.
•  Y 21  Y 22  Y2n
  ........ 
 Y 11  Y 12  Y1n
 MRPS and enterprise relation ships

MRPS Enterprise relationship

∆Y2/∆Y1 > O Complementary

∆Y2/∆Y1 < O Competitive

∆Y2/∆Y1 = O Supplementary
Iso-revenue line
• It represents all possible combination of two products which would yield an equal (same) revenue or income.
• Slope of iso-revenue line is determined by ratio of prices for the two competing products.

Characteristics:
1) Isorevenue line is a straight line because product prices do not change with quantity sold.
2) As the total revenue increases, the isorevenue line moves away from the origin since the total revenue
determines the distance of it from the origin.
3) The slope indicates ratio of product (output) prices. As long as product prices remaining constant, the
isorevenue line showing different total revenues are parallel.
4) Change in either price will change the slope.
Y2 Rs.900

Y1
 Isocline and ridge line for product- product relationship

• Ridge line can be used to separate the range of product competition

from range of complementary.
•Within the ridge line PPC have negative slope indicating competition.
•Portion outside ridge line have positive slope indicating complementary
relationship.

Expansion path in product–product analysis

Y2

Y1
• All these iso-revenues lines are tangent to the production possibility curve at different points.
• The line connecting these equilibrium points is the expansion path.
• All points of tangency specify the most profitable enterprise combination for different production possibility
curves with the price indicated by the iso-revenue lines.
• As one moves up the expansion path, total revenue increases but total costs also increase.

Determination of Optimum Product Combination

1. Tabular Method:
• Compute total revenue for each possible output combination and then select that combination of outputs
which yields maximum total revenue.
• This method is useful only when we have few combinations.
.

72 quintals of maize and 26 quintals of cotton yield maximum revenue.

2. Algebraic Method:
• There are three steps to determine the optimum product combination
a) Compute Marginal Rate of Product Substitution
• MRPS =Number of units of replaced products/Number of units of added product
• MRPSY1Y2 = Y2/ Y1
• MRPSY2Y1 = Y1/ Y2
b) Workout price ratio (PR)
• Price Ratio (PR) = Price per unit of added product/Price per unit of replaced product
• PR= P y1/Py2 if it is MRSY1Y2
• PR= Py2/ Py1 if it is MRSY2Y1
c) Optimum combination of enterprises is at where MRPS=PR
No _ of _ replaced _ product Pr ice _ of _ added _ product
• No _ of _ added _ product

Pr ice _ of _ replaced _ product
• Y2/ Y1= Py1/Py2
Or
• Y1/ Y2 = Py2/ Py1
3. Graphic Method
• Draw production possibility curve and isorevenue line on one graph.
• Slope of production possibility curve indicates MRPS and the slope of isorevenue line indicates price ratio of
products.
• The point of optimum combination of products is at where the isorevenue line is tangent to the production
possibility curve.
• At this point, slope of the isorevenue line and the slope of the production possibility curve will be the same. In
other words, the MRPS=PR.

Y2
Optimum product combination

Y1
Principle involved in farm management decisions

1. Principle of variable proportion (Law of diminishing return)

2. Principle of factor substitution
3. Principle of product substitution
4. Cost principle
5. Opportunity cost principle
6. Law of equi-marginal return
7. Time comparison principle
8. Principle of comparative advantage
1. Law of diminishing return (law of variable proportion)
This law states in short run keeping other factors fixed, if we increase one variable input, marginal product
initially increases at increasing rate, then at constant rate followed by decreasing rate and then production go
down.
• This principle explains input-output relationship.
• It helps farm manager in making decision how much to produce.
• This helps in determination of optimum level of input to use and optimum level of output to produce.
Assumption of this law
1. Fix and variable input- at least one factor input is constant and one factor input is variable
2. Short run- because in long run all the factors are variable
3. Change in factor proportion – ratio of variable input to constant input should must keep on changing.
4. Constant technology
5. Homogenous factor of production- if first labor is adult ,second also should be adult not children
6. Input prices remain fixed
7. Only one factor is allowed to vary keeping all other factor constant.
8. Cultivated soil should not be new soil
Three stages of this law: a) Increasing marginal return b) decreasing marginal
return c) negative marginal return
Fertilizer(X) in kg Wheat (Y) in kg Marginal return Remarks

0 20 -

1 25 5 Increasing

2 31 6

3 35 4 Constant

4 39 4

5 42 3 Decreasing

6 45 2

7 46 1

8 45 -1 Negative

9 44 -2
Limitations of law of diminishing return
• Newly cultivated land
• Improvement in method of cultivation – better irrigation, improved seed etc.
• Improvement in art of agriculture- eg bullocks replaced by tractor
• Inadequate application of labor – If proportion of labor to land is inadequate, the productivity at first
increases and law may not operate for certain period.
• Use of insufficient and inadequate capital.
Reason for law of diminishing returns specially applied in agriculture
• Role of nature – Agriculture depends greatly on nature which is unpredictable for eg weather conditions
(rainfall, temperature).
• Land is a fixed factor – Supply of land is fix and production has to be done within limited land.
• Less scope of division of labor- No specialization of labor for particular activity. Single labor has to plough,
dig, transplant, harvest etc.
• Less use of machine- Minimum use of machine and other improved methods for production.
• Seasonal nature of work- Agricultural laborer are engaged for only one season and at other season they
remain idle. So total productivity with respect to input go on decreasing.
• Less supervision of work and progress-
• Fertility of soil gradually falls.
2.Principal of factor substitution
• Also called principle of least cost combination.
• This economic principle explains one of the basic production relationships- factor-factor relationship.
• It guides in the determination of least cost combination of resources. It helps in making a management
decision of how to produce.
• Substitution of one input for another input occurs frequently in agricultural production. For example, one grain
can be substituted for forage in livestock ration, chemical fertilizers can be substituted for organic manure,
machinery for labour, herbicides for manual weeding etc.
• The farmer must select that combination of inputs or practices which will produce a given amount of output
for the least cost.
• In other words, the problem is to find the least cost combination of resources, as this will maximize profit from
producing a given amount of output.
• Definition-The principle of factor substitution says that go on adding a resource as long as the cost of resource
being added is less than the saving in cost from the resource being replaced.
Steps:
1. Compute marginal rate of technical substitution
Amount of replaced resource
MRTS =
Amount of added resource
∆X2
= —
∆X1
2. Compute price ratio
Price of added resource
Price ratio =
Price of replaced resource
PX1
= PX2
3. Find point where MRTS = Price ratio
∆X2 PX1
= —=—
∆X1 PX2

4. Decision rule: If ∆X2 PX1

—>—
∆X1 PX2
or, ΔX2.Px2 > ΔX1.Px1 , then use of more of X1 resource to get the benefit.
If ∆X2 PX1
—<—
∆X1 PX2
Or, ΔX2Px2 < ΔX1Px1 ,then use of more of X2 resource to get the benefit
If ∆X2 PX1
— = — least cost combination.
∆X1 PX2
The least cost combination of grain and hay is a combination of 1200 kgs of grain and 520 kgs of hay, as
the substitution ratio equals price ratio.
Fig. Least Cost combination
3.Principle of product substitution
•Various combination of output can be produced.
•Among them most profitable combination has to be chosen.
• Definition: It is economical to substitute one product for another product, if the decrease in returns from the
product being replaced is less than the increase in returns from the product being added.
•The optimum level of two products will be there when marginal rate of product substitution is equal to slope of
iso- revenue line or price ratio of the products.

Steps
1.Compute marginal rate of product substitution
Amount of replaced product
MRPS =
Amount of added product
=
2. Compute price ratio
Price of added product
Price ratio =
Price of replaced product

=
3. Find point where MRPS = Price ratio
=

4. Decision rule:
•If <

ΔY1.PY1 < ΔY2PY2 , increase the production of Y1 if Y1 is substitute for Y2

•If >
Or, ΔY1Py1 >ΔY2PY2, increase the production of Y2 if Y1 is substitute for Y2

If, = Optimum product combination

 (Products)

•Up to fifth combination MRS is less than PR.

•But at the sixth combination MRS is equal to PR.
•Therefore, the sixth combination which produces 100 qunitals of corn Y1 and 16 qunitals of wheat Y2 is the
optimum or profit maximizing combination.
• Optimum combination of production
•It deals with product-product relationship.
•It helps in determination of optimum product combination.
•Major goal of this law is profit maximization. This law guides farm manager in making decision about what to
produce.
4.Cost principle:
• Cost refers to value of resource or inputs that have been used to produce something.
• Cost is monetary valuation of effort, material, resources, time and utility consumed, risk incurred and
opportunity forgone in production and delivery of goods and services.
• Cost can be defined as total amount of funds used in production.
• Cost principle explains how losses can be minimized during the period of price adversity.
 Cash Cost and Non Cash Cost
• Cash costs are incurred when resources are purchased and used immediately in the production process. For the
most, cash costs result from purchases of non durable inputs such as fertilizers, fuel oil, labor charge which do
not last more than one production period.
• Non-cash cost includes depreciation and payments to resources owned by the farmers. Examples are
depreciation on tractor, equipment, buildings, family labor, management and owned capital.
• Cost= X.Px (for one input)
• Cost=X1.P1 + X2.P2+……..+ Xn.Px (for many input)
•TC=FC+VC
 Money cost
 Real cost
 Opportunity cost
 Social cost
 Explicit cost
 Implicit cost
 Fixed cost
• Cost from fix inputs eg- rent of land, buliding, salary of regular employee etc.
• Does not change with change in output.
• Fix cost are not permanently fixed. They can change in long run.
 Variable cost
• Cost incurred on purchase of variable inputs eg labor wage, cost of raw materials etc.
• Cost varies with output.
• Cost rises as production increases and fall as production decreases.
 Average cost
Total cost per unit of output.
AC =
 Marginal cost
Refers to change in total cost per unit change in output.
MC=
Application of the fixed and variable cost principle
•In the short run, gross revenue must cover the variable cost. Maximum revenue is obtained when MC=MR.
•If the gross revenue is less than the total cost but greater than variable cost, guiding principle should be keep
on production as long as MR is greater than MC.
Application of cost principle in short run
• Fix cost has no impact on short run cost. Only variable costs effect short run production costs.
• In short run fixed cost remain same where as variable cost first increases with decreasing rate, then
becomes some what constant and then increases with increasing rate.
• Here, selling price should be greater then average variable cost.

Fig. Short run cost

Applications of cost principle in long run
• In long run all cost are variables. There is no fixed cost.
• Gross return should be greater than total cost.
• Resource should be used as long as added return (MR) is greater than added cost (MC).
• Selling price should be greater than average cost.
Equilibrium in the production

•Equilibrium is at the point where Marginal revenue(MR) = Marginal cost(MC)

Other application of cost Principle
Measurement of profit
Profit= Total revenue- Total cost
Condition for profit maximization
• Ω = TR- TC (maximum)
• Marginal revenue (MR) = Marginal cost (MC)
To determine shut down point
• If firm average revenue cover only average variable cost, the firm is in loss equal to average fix cost.
• Thus, firm should stop production. This condition is called shut down point.
To determine breakeven point
• It is the point where firm revenue just cover cost of production.
MC
• At this condition firm is neither in loss nor in profit.
• After this point firm starts to obtain profit.

LAC

Fig. Breakeven point

To know economics of scale

• It is important tool to determine size of farm production. LAC

• It is the condition where LAC (Long run average cost) decreases

as production increases.
PROFIT OR DECISION RULES
 SHORT RUN:
1. If expected selling price is greater than average total cost (ATC), profit is expected and is maximized by
producing where MR = MC.
2. If expected selling price is less than average total cost (ATC) but greater than average variable cost (AVC),
a loss is expected but the loss is less than TFC and is minimized by producing where MR = MC.
3. If expected selling price is less than average variable cost (AVC), a loss is expected but can be minimized
by not producing anything. The loss will be equal to TFC.
 LONG RUN
1. Production should continue in the long run when the expected selling price is greater than average total cost
(ATC).
2. Expected selling price which is less than ATC result in continuous losses. In this case, the fixed assets should
be sold and money invested in more profitable alternative.
5.Opportunity cost Principle
•Value of next best alternative foregone.
•In agriculture resources are limited and have alternative uses.
•When resource is put to one use, opportunities of other alternatives are lost.
•The resources of any firm are limited and investment options are many. The firm has to select only the
investment options which provide the firm the best returns. While doing so, the firm gives up the next best
option for investing the fund.
• Opportunity cost is benefit, profit or value of something that must be given up to acquire or achieve
something else.
• Eg if someone has car he can use it for travelling from one place to other for his pleasure or can rent for
other. Out of two choices he can select one. If he use for his pleasure then opportunity cost would be amount
of rent he would have earned.
• If a person has 1 hector of land then he can use it either for growing crops or for rearing animal. If he use it
for growing crop then the amount he could have earn from rearing animal and vise versa is his opportunity
cost.
• Farmer has 2 quintal of fertilizer. It adds Rs. 250 to the total revenue from wheat and Rs. 200 revenue from
barley. If he fertilizes barley, his opportunity cost is Rs. 250, which has foregone on wheat. If he fertilizes
wheat, his opportunity cost is Rs. 200 foregone on barley
6.Principle of Equi-marginal return
• Most of the farmers have limited resources.
• They have limited land, limited capital, limited irrigation facilities etc.
• Under such resource limitations, farmers must decide how a limited amount of input should be allocated or
divided among many possible uses or alternatives.
• For example farmer has to decide on the best allocation of fertilizer between different crops and feed between
different types of livestock. In addition, limited capital must be allocated to the purchase of fertilizers, seeds,
feed etc.
• The equi-marginal principle provides guidelines for the rational allocation of scare resources.
• According to this law resource should be used where they bring not only greatest average return, but also
greatest marginal return.
• The principle says that returns from the limited resources will be maximum if each unit of the resource should
be used where it brings greatest marginal returns.
Statement of the law
• For profit maximization, limited input should be allocated among alternative uses in such a way that the
marginal return of the last unit are equal in all its uses.
 For eg: there is Rs. 50000 for investing and locality is favorable to take crop, dairy and poultry enterprise.
 Returns

Average return per 1.52 1.44 1.56

rupee invested
Returns
• Cultivator is getting total net profit of Rs. 48000 which is more than profit from any single enterprise. Thus
for maximum net profit cultivator should invest Rs20000 in crop, Rs20000 in poultry and Rs10000 in dairy
enterprise. It is observed from the above table that marginal returns from all three enterprises are equal i.e.
Rs19000.
• Thus it can be stated that amount should be invested in such a way that marginal returns should be equal in
all the alternatives.
7.Time comparison principle
• Various farm decisions involve time.
• For example, a farmer has to decide between a cereal crop which would be harvested after about four months
or an fruit orchard which would start giving returns after three years.
• Further, a farmer has to decide whether to purchase new farm machinery with 10 years of life or a second hand
one which may have only five years of life.
• Several other decisions involving time and initial capital investment could be judiciously taken by
compounding or discounting.
• Difference in value of money today and tomorrow is referred as time value of money.
• Money available at present worth more than same amount in future due to its potential earning capacity.
 Present value of future amount
• Present value of future sum refers to the current value of sum of money to be received in the future.
• The procedure to find the present value of future sum is called discounting .
• The equation for finding the present value of future sum is

PV= Present value

FV= Future value
i= interest rate
n= number of years.
• Example:
• Find the present value of Rs. 1000/- to be received in 5 years using an interest rate of 8%.
• PV = (1000/(1 + 0.08)^5
• = 681
• A payment of Rs. 1000 to be received in 5 years has a present value of Rs. 681 at 8% interest.
• Example: A farmer wants to purchase a tractor. The alternatives are,
1. Purchase a new tractor for Rs. 25000/- that will last 10 years.
2. Purchase an old tractor for Rs. 15000/- and replace it after 5 years with another old tractor worth Rs. 15000/-.
This means that he shall have to invest Rs. 15000/- now and lay aside an amount which will become Rs.
15000/- within 5 years to replace the old tractor.
A) Farmer with unlimited capital has the opportunity of lending the money at usual interest rate, say 5%.
• PV= 15000/(1+0.05)^5
= Rs. 11,760
• His comparison is Rs. 25000/- for new tractor and Rs. 15000/- plus Rs.11,760/- (Rs. 26760/-) for old tractor.
The new tractor is profitable for the farmer with unlimited capital.
B) Farmer with limited capital has an opportunity of investing money in poultry and can make a return of 15 %
within the year. His discounting rate will be 15% i.e., opportunity cost of not using money in bank and
investing in poultry.
• PV= 15000/(1+0.15)^5
= Rs. 7,455
• His comparison is Rs. 25000/- for new tractor and Rs. 15000/- plus Rs. 7455/- (Rs. 22455/-) for old tractor.
The old tractor is profitable for farmer with limited capital.
Future value of present amount
• Procedure of estimating future value of present amount is called compounding.

PV= Present value

FV= Future value
i= interest rate
n= number of years.
Ex: Rs100 @ 10 % interest rate after 4 years
•First year: 100+10=110
•Second year: 110+11=121
•Third year: 121+ 12.10=133.10
•Fourth year: 133.10 + 13.31=146.4
•By formula, FV= PV ( 1+ i)^n= 100( 1+0.10)4= 146.4
8.Principle of comparative advantage:
•Comparative advantage refers to region’s ability to produce particular goods with lower opportunity cost
than other region.
•Different location or region have different soil and climatic conditions so that there is differences in yield,
cost, and returns while crops and livestock enterprises are raised that ultimately leads to the specialization in
the production for particular region.
•In this case, law of comparative advantage guides the producer for specialization of particular commodity in
particular location based on the economic advantages (relative yield, cost and return are the criteria).
• There are two types of advantages in the production of farm commodities:
• Absolute advantages: It is the size of the margin or difference between the cost and return from using
productive input. If the margin is larger for one farm commodity in one region then that region has
absolute advantage in producing that commodity.
• Comparative advantage: A region may have more absolute advantages for more than one commodity but a
farmer should specialize in that commodity which have more return per unit of investment among all other
alternatives.
• Statement of the principle
• Individuals or regions will tend to specialize in the production of those commodities for which their
resources give them a relative or comparative advantage.
For eg- Jumla district has the ability of producing apple at lower opportunity cost as the existing climates
and attitude favor for apple production with low per unit production cost.
• The following example illustrates the principle of comparative advantages.

• Region A has greater absolute advantage in growing both wheat and groundnut than Region B because the net
incomes per acre are Rs. 75 and Rs. 25 respectively which are higher than the net incomes from wheat and
groundnut in Region B.
• Farmers of Region A can make more profits by growing both the crops.
• But farmer can make greatest profit by growing wheat in Region A and Region B can obtain more relative
advantage by growing groundnut.
9.Principle of combining enterprises
1.Independent enterprises – Increase in level of one neither helps or hinders the level of production of other.
This relationship is rare and is possible with practically unlimited supplies of inputs. Each product should
treated separately.
2.Competitive enterprises- Compete for the use of farmers limited resources. Use of resource to produce
more of one necessitates a sacrifice in quantity of other product.
3.Supplementary enterprise- Increase in level of one does not adversely affect the production of other but
adds to the total income.
4. Complementary enterprise- Increase in production of one product also causes increase in production of
other.
5. Joint enterprises- Product which are produced together or produced by same production process. Quantity
of one decides the quantity of other product. Eg. Mutton and wool.
 Difference between comparative and competitive advantage

Comparative advantage Competitive advantage

- Ability of particular location to produce goods at - Ability of firm to produce good either at lower price
lower opportunity cost. or provide good and services that satisfies higher price.
-Focuses on external economics. - Focuses on internal economics.
- Based on resource endowment. - Based on value addition.
- Focus on market size. - Stress is given for product differentiation.
- Emphasis macroeconomic principals. - Emphasis microeconomic principals.
- It is top down approach. - It is bottom up approach.
Practical
TO STUDY PRINCIPLES INVOLVED IN FARM MANAGEMENT DECISIONS
OBJECTIVES-
1. To study principle involved in farm management decisions.
2. To know the role of various principles for appropriate farm management decisions.
THEORY
Enlist all principles.
Briefly describe each principle.
CONCLUSION
 Risk and Uncertainty
• Concept
• Types
• Safeguard measures
Risk
• Risk and uncertainty are two classes of imperfect knowledge. Risk represents less imperfections or more
perfection in knowledge than uncertainty.
• Risk is an environment in which possible outcomes and their respective probabilities are known.
• Under risk, the occurrence of future event can be predicted fairly accurately by specifying the level of
probability.
• When risk situation prevails it can be said, for instance that the chances of a hailstone at the time harvesting
5:95 or 20:80. A priori risk prevails when sufficient advance information is available about the occurrence
of an event.
• For instance, probability of head or tail occurring is unbiased at coin tossing. On the other hand, statistical
risk can only be predicted on the basis of occurrence of several observations in the past.
• These are the things we know we don’t know.
• These are known unknowns.
• For eg. If you plan to pick up a friend from airport, the probability that their flight will arrive few hours late
is a risk and plan accordingly.
Uncertainty
• Uncertainty is an environment in which possible outcomes and their respective probabilities are not known.
• Thus the future occurrence of an event can not be predicted.
• Unknown unknowns
• For eg you may be late on picking up your friend from airport because an accident happened and hour before
you planned to leave for airport and you had to visit the doctor.
• In this case we cannot predict the future based on past events.
Types of Risk and Uncertainty
1.Economic uncertainty
• Price expected before sowing or at the time of planning may not be same at the time of implementation and at
the time of harvesting.
• The price may fall far below the expectation or may rise far above the expectation.
• Commodity price vary from year to year , within a year and from day to day. For instance, the price of raw
rice is expected to be at least Rs. 1000/qtl fall less than Rs. 200/qtl.
• The competitive structure of domestic and international commodity markets exposes producers to unexpected
fluctuations of price.
2. Technological uncertainty
Another source of production risk is new technology. Will the new technology perform as expected? Will it
actually reduce costs and increase yields? These questions must be answered before adopting new technology.
3. Institutional uncertainty
Institutional like government, banks etc. may also cause uncertainties for an individual farmer. For instance,
crop tax, support price, subsidies, etc. may be enforced or withdraw without taking an individual farmer into
confidence. This type of uncertainties may also result in unavailability resources in appropriate quantities and
at the appropriate time and place. Other different government policies that can affect farm business includes
regulation for chemical use, quarantine and other trade barriers, institutional arrangement for markets, setting
occupational health and safety regulations, overseeing consumer and food safety etc
4. Biological uncertainty
Agriculture is being the biological in nature, this type of risk and uncertainties are quite common and
important. Heavy rainfall, drought, floods and hailstones are directly or indirectly affect the production of
agricultural commodities by increasing the incidence of diseases or insects, weeds etc
5. Personal uncertainty
Human being, being the biological in nature may suffer from several ecological, physical or health disorder
causing the serious problem in planning. Major life crises such as accidents, illness, death of owner, conflict
between partners owning a farm in partnership etc. can threaten the profitability of farm business.
Component (types) of Risk
• The components of risk in a production function can be best understood by the equation of the profit
function: π=PY*Y- ΣPi*Xi-FC
• Where, π is the profit, Y and X are the quantity of output and input respectively and PY and Pi are the prices
of output and inputs respectively. From the equation it is evident that the prices of input and output and the
yield of the output are the main components of risk.
1. Price risk
Inputs are used at the beginning of the production season and the decision makers have certain information
about the price of input and hence prices of inputs are not that much important in risk analysis. However the
output is realized only at the end of the production season. The decision regarding the level of output has to
be taken before start of the season and hence it is necessary to see the risk associated with price of the
output. Support price and forward contracting are the measures to reduce risk associated with price to some
extent.
2. Yield risk
Variation in yield of an enterprise depends on several factors and as we know climate and weather are the
measure factors. Yield risk can be reduced by crop insurance and yield insuring scheme.
Safe guard against Risk and Uncertainties
1. Maintenance resources in reserves
2. Adaptation of enterprise with low risk- eg- cereals production is less risky than vegetable
production.
3. Forward contract
The forward contract is an effective tool for eliminating risk or uncertainty. Any contractual arrangement
that at the start of the production season specifies a price to be received at the end of the season will
eliminate price uncertainty. Contractual arrangements are commonly used for commodities such as
broilers, horticultural crops and sunflowers. The contract is written at planting time or prior to
harvesting, between farmer and purchaser, which may also specifies the quality and quantity of produce
to be delivered by the farmer.
4.Share cropping
5. Diversification
The idea behind a diversification strategy is to let profits from one type of livestock or crop enterprise
more than offset losses in another enterprise. Diversification may also make effective use of labor and
other inputs throughout the year, thus increasing income in both good years and bad. The strategy may be
more effective for dealing with price uncertainty. Enterprise diversification can reduce yield, price and
income risk by exploiting the fact that different crop will react differently to the events that occur.
6. Conglomeration: The unrelated products in the business is called conglomeration. For ex: egg and
sugar
7.Integration: Farming should be integrated because our farmers are risk avoiders
Vertical integration – milk production, processing and marketing in single firm.
8. Adoptation of complementary and supplementary enterprise
9. Flexibility: Time, cost and product
Cost flexible: Keeping fix cost low and incurring higher variable cost as necessary. purchasing of small
equipments rather than hiring.
Time flexible: speed at which adjustment to farm operation can be made. Vegetable farming is more flexible
than orchard.
Products flexible: Enterprise produce more than one product or produce the product that has more than one end
use. Eg poultry is more product flexible than goat farm.
10. Spreading sales: Instead of selling the entire crop output at one time, farmers prefer to sell part of the output
at several times during the year. Spreading sales avoids selling all the crop output at the lowest price of the
year but also prevents selling at the highest price.
11. Hedging: It is a technical procedure that involves trading in a commodity futures contracts through a
commodity broker.
12.Liquidity (crop) and asset management
• Liquidity is willingness to have cash. Assets or capital may be physical (road), human (labour or technical
manpower), environmental (firewood), and socio-cultural. Farmers try to manage the capital.
Other risk management measures to be adopted by government
12.Insurance-For phenomena, which can be insured, possible magnitude of loss is lessened through converting
the chance of large loss into certain cost. There might be various types of insurance contracts available for
farmers crop insurance, livestocks insurance, assests insurance,insurance for workers etc.
13.Subsidy and support prices
14.Providing institutional loan and marketing facilities.
15.Acreage control
16. Forecasting of required informations- weather and crop related informations.
Steps in risk management
• Identification of risky events
• Anticipation of probable outcomes and their consequences.
• Taking action to obtain a preferred combination of risk and expected returns.
• Restoring the capacity of the firm to implement future risk planning strategies.
Measurement of Risk
The dispersion of possible outcomes such as gain or losses can be estimated when a particular course of
action is followed.
Standard deviation of distribution can be the best measure the risk when the possible outcome are normally
distributed.

Standard deviation (𝞼) =

( X  X ) 2

Where, X= observation, X= means of observation, N= numbers of observations

Note- Higher the standard deviation of expected outcome ,higher would be the risk.
• Difference between risk and uncertinity
Risk
Represents more perfection in
knowledge than uncertainty
Can be measured and quantified
We can assign probability to risk
Can be managed
Example: Chances of hailstone or pest or
disease or price risk
Uncertinity
than uncertainty Represents less
perfection in knowledge than risk.
Can not be measured and quantified
We can not assign probability to
uncertinity.
Cannot be managed
Example: Climate and weather conditions
Practical
Assessment of agriculture risks and their safeguard measures
Objectives
To know different types of risks in agriculture
To know various safeguard measures to risk and uncertainity.
Theory
Conclusion
 Farm planning and budgeting

• Concept of farm planning and budgeting, its advantages and planning techniques
• Characteristics of a good farm plan and steps of farm planning
• Types of farm budgeting: partial, enterprise and complete budgeting
Farm planning and budgeting
1.Farm Planning
Plan
• Any diagram or list of steps with timing and resources, used to achieve an objective.
• It is set of intended actions through which one expects to achieve a goal.
Planning
• Creation of plan.
• Process of thinking about and organizing the activities required to achieve the desired goal.
Farm plan
• A farm plan is programme of total farm activity of a farmer drawn up in advance.
• A farm plan should show the enterprises to be taken up on the farm; the practices to be followed in their
production ,use of labour , investments to be made and similar other details.
• Farm plan represent overall situation of farm, including objectives, available resource and its management,
farming practices and expected costs and benefits.
• An optimum farm plan will satisfy all the resource constraints at the farm level and yield the maximum
profit.
TYPE OF FARM PLANS
1. Simple farm plan
• It is adopted either for a part of the land or for one enterprise or to substitute one resource to another.
• This is very simple and easy to implement.
• The process of change should always begin with these simple plans.
2. Complete or whole farm plan
• This is the planning for the whole farm.
• This planning is adopted when major changes are contemplated in the existing organization of farm business.
• Characteristics of Good farm plan
1. It is should be clearly written and well organized.
2. It should be flexible..
3. It should provide for efficient use of resources like land labor, equipment etc.
4. Farm plan should have balanced combination of enterprises. Such combination should ensures,
a. Production of different crops like food, cash and fodder crops.
b. Improve and maintain soil fertility.
c. Help to expand income.
d. Improve distribution and use of labour, power, water and other resources throughout the year.
5. Avoid excessive risks.
6. Utilize farmer’s knowledge and experience and take account of his likes and dislikes.
7. Facilitates efficient marketing.
8. Provision for borrowing, using and repayment of credit.
9. Enables to use latest technology.

Farm Planning
• Farm planning is a decision making process in the farm business, which involves organization and
management of limited resources to realize the specified goals continuously.
• Farm planning involves selecting the most profitable course of action from among all possible
alternatives.
• It enables to decide at present, what to do in the future about best combination of enterprises and
judicious use of resource which will increase resource use efficiency and farm income.
• Farm planning helps to get all idea of farm from farmer to paper and to action.
Objectives of Farm Planning
The ultimate objective of farm planning is the improvement in the standard of living of the farmer and immediate
goal is to maximize the net incomes of the farmer through improved resource use planning.
Thus, the main objective is to maximize the annual net income sustained over a long period of time.
Farm planning causes maximization of profit of farm through
• Providing ideas about alternative methods and practices.
• Reveals resource status in the farm
• Helps to make rational decision within the framework of new ideas and opportunities and resource position.
• Give ideas of input requirements like seeds, plant protection materials, fertilizers etc.
• Capital requirements can be known
• Fore cast of expected income.
Advantages of farm planning
Income improvement
• Provides opportunities to farmers to increase farm income.
• Income maximization can be achieved from given amount of resource by re organizing present type of
production as well as introduction of new technology.
Educational process
• Farm planning is an educational tool to bring change in outlook of farmers and extension workers.
• Knowledge of latest technology is pre- requisite for better farm planning. So farm plan enforce farmers to
remain up to date to new technologies at the time of planning process.
• It act as self educating tool for farmers.
• . The farmers can closely study their own business and see more clearly their opportunities and limitations,
thus, improving their managerial ability.

Desirable organizational change

• It treat farm as an operational unit and tailoring the recommendations to fit into the individual farmer’s
opportunities, limitations, problems and resource position.
How does farm planning helps to farmers ?
i. Assess the farm business and environment in which it operates- where the farmer is and where he may
want to go?
ii. Identify the goals of farm business – what the farmer wants to accomplish?
iii. Gather ideas on alternative methods/practices which might be useful to farmers in his farming business
iv. Analyze the performance of farm business- how the farmer has done in the past based on historical
financial statements.
v. Identify farm resources- examine the existing resource situation as a basis for deciding which
enterprise and method fit the farmer’s situation the best.
vi. Decide upon the course of action- make a rational decision on what to do within the framework of new
ideas and opportunities and farmer’s own resource position.
vii. Take decision in relation to selection of crops, acreage under different crops and number of livestock to
be maintained.
viii. Identify the inputs and credit needs of his alternative improved plan.
ix. Estimate future costs and returns- give farmer an idea of expected net income.
x. Enable the farmer to achieve his or her objectives in relation to his farm and family in more organized
manner.
xi. Evaluate the farm plan- whether it is working.
Components of Farm Planning
a) Statement of the objective function:
• Many farmers aim at profit maximization.
• However, some may have other objectives like to fulfill cereal requirements of the family and fodder needs
for the livestock.
b) Inventory of scarce resources and constraints
1) Land: Location, topography, soil type, fertility, drainage, irrigation systems and so on affect enterprises in
many ways and hence, it is useful to divide all the land on a farm into different enterprises.
2) Labour: On subsistence farms, all labour is supplied by the farmer and his family. Thus, it is important to
record the number of workers - male, female and children - and the type of manual work each is prepared is
undertaken. However, in commercial farms, hired labour constitutes a major component of costs and thereby
inviting more attention in the planning process.
3) Capital: Whether fixed, like buildings and machines, or circulating, like cash in hand or in the bank, capital
acts as a very powerful constraint.
4) Personal: Farmers’ past experience, attitude towards risks and uncertainties and personal likes and dislikes
influence the choice of enterprise.
5) Institutional: Market often serves as a constraint for the production of vegetables, poultry, milk, etc. Even if
the location of the farm is suitable for a particular crop (commodity), a contract may still have to be obtained.
E.g. Sugarcane growing near the sugar mills. Similarly, though many parts of Himachal Pradesh are suitable
for poppy cultivation, the government has banned its cultivation.
6) Rotations: Maximum permissible area under a particular crop in a given season or minimum area constraints
imposed on the acre under some crops like legumes would serve in maintaining soil fertility and help
controlling pest and diseases.
c) Alternative Choices: Alternative choices in planning refer to the various enterprises, crops and livestock,
which can be considered for attaining the stated objectives. There are alternate ways to use the scarce farm
resources. There may be more than one ways to produce the same enterprise. A comprehensive list of different
alternative enterprises can be prepared.
d) Input Output Co-efficients: The requirements of each of the several scarce resources and the financial
returns per unit of each enterprise or activity need to be considered here. The precision in planning depends
more on accurate input-output data than on the technique of planning.
e) Planning Technique: With a proper understanding of the planning environment and use of precise input-
output data along with true and realistic constraints, sophisticated techniques give better results. However,
common sense in the planning process could lead to fairly good results. Some of the farm planning techniques
are as listed below:
1. Budgeting.
2. Linear Programming.
2.FARM BUDGETING
• Farm budgeting is an advance method of estimating expected income, expenses and profit for a farm
business.
• Budgeting can be used to select the most profitable plan from among a number of alternatives and to test
the profitability of any proposed change in plan.
• It involves testing a new plan before implementing it, to be sure that it will improve profit.
• Farm budgeting refers to farm plan presented in monetary term.
• Planning without calculating the receipt and expenses in monetary term is not of much use. So, farm
planning and budgeting should go side by side.

Objectives of farm budgeting

• To serve as a basis of farm plan preparation and its evaluation.
• Aids in adopting farming method which meet market demand and help to have higher return on investment.
Application of the farm budget
Application prior to crop season
• To outline programme of work.
• To indicate planned organization.
• Operational practices from the standpoint of management principles.
• It supplies a method by which a farmer can make major mistakes on paper before the season starts and then
find and correct these mistakes before they affect farmer’s returns or repaying capacity.
Application during farming season
• A farm plan is best used during the operations as a flexible guide or yard stick and not as fixed rule for every
operation.
• Farm plan serves as a compass to keep operator on right track.
Application at the end of the season
• The analysis of the estimated results as compared with actual results from each of individual enterprises and
the entire farm business as a unit serve to make future plans more effective in determining the strong and
weak points of farm business and in planning for improving the efficiency and increasing net earning.
Importance/Advantage of farm budgeting
• It helps in analyzing business carefully.
• It helps in preparing statement of receipts and expenditure.
• It evaluate old plans and guide to adopt new plan with advantages.
• Make farmers conscious about waste or leakage in farm business.
• Give comparative study of receipts, expenses and net earning on different farms in the same locality and in
different localities for formulating national agricultural policies.
• Guide and encourage the most efficient and economical use of available resources.
• It helps to draw alternative plan for quick improvement on existing plan.
• It serves as the basis for future improvement in farm management practices.
Types of farm budgets
1. Enterprise budget
• An enterprise is defined as a single crop or livestock commodity being produced on the farm.
• An enterprise budget is an estimate of all income and expenses associated with a specific enterprise and
estimate of its profitability.
• Enterprise budget can be developed for each actual and potential enterprise in a farm plan such as paddy
enterprise, wheat enterprise or a cow enterprise.
• Each is developed on the basis of small common unit such as one acre or one hectare for crops or one head for
livestock.
• This permits easier comparison of the profit for alternative and competing enterprises.
• It helps to determine which enterprise might be expanded and those should be eliminated.
• Enterprise budget can be organized and presented in three sections income, variable costs and fixed costs.
• The first step in developing an enterprise is to estimate the total production and expected output price.
• The estimated yield should be an average yield expected under normal weather conditions given the soil type
and input levels to be used.
• The output price should be the manager’s best estimate of the average price expected during the next year or
next several years.
• Variable costs are estimated by knowing the quantities of inputs to be used (such as seed, fertilizer, labour,
manures) and their prices.
• The fixed costs in a crop enterprise budget are depreciation on machinery, equipment, implements, livestock,
farm building etc., rental value of land, and revenue, interest on fixed capital.
Example: Enterprise budget for wheat cultivation (one hectare)
Items Value (Rs)
I) ESTIMATED INCOME
48 quintals @ Rs. 600 per quintal 28,800
II) ESTIMATED VARIABLE COSTS
1. Human labour 9,000
• a) Owned 3,000
• b) Hired 6,000
• 2. Bullock labour 300
• a) Owned 100
• b) Hired 200
• 3. Tractor power 4,000
• 4. Seeds 1,200
• 5. F.Y.M. 1,800
• 6. Green leaf manures 700
• 7. Fertilizers 3,000
• 8. Plant protection chemicals 500
• 9. Irrigation charges 500
• 10. Interest on working capital 1,700
• Total variable costs 22,700
• III)ESTIMATED FIXED COSTS
• 1. Land revenue 12
• 2. Depreciation 900
• 3. Rent on owned land 3,500
• 4. Interest on fixed capital 450
• Total fixed costs 4,862
• Total costs (TVC+TFC) 27,562
• Gross margin (T.R. - T.V.C.) 6,100
• Estimated Profit (T.R.-T.C.) 1,238
S.N Items Rate Quantity Total
1. Estimated Income
a.
b.
Total revenue (TR)
2. Estimated Variable cost(VC)
a
b
Total variable cost (TVC)
3. Estimated Fixed Cost (FC)
a
b
Total fixed cost (TFC)
Total cost (TC)= TVC+TFC
Profit/loss= TR-TC
2. Partial budget
• It is used to calculate the expected change in profit for a proposed change or possible adjustment in the the
farm business.
• Partial budget is best adopted to analysing relatively small change in the whole farm plan.
• It is simple, quick and easy.
• Changes in the farm plan or organization adopted to analysis by use of partial budget are of three types.
1. Enterprise substitution:
This includes a complete or partial substitution of one enterprise for another. For example, substitution of
sunflower for groundnut.
2. Input substitution :
Example : Machinery for labour, changing livestock rations, owning a machine instead of hiring, increasing or
decreasing fertilizers or chemicals.
3. Size or scale of operation:
This includes changing in total size of the farm business or in the size of the single enterprise, buying or renting
of additional land , expanding or decreasing an enterprise.
•Example Comparison of split doses Vs single dose of Nitrogen application to rice crop in 10 katha
Debit Credit
a. Increasing cost per 10 Katha Rs a. Increase in return of 10 katha Rs.

1.Labor for second application of 100 1.Increase yield 1 qtl @ Rs. 10000
urea at tillering stage required 1 hr 10000/qtl
@ Rs. 100/hour

2.Labor charge for third application 100 2.Rice straw 150 Kg/10 Katha @ 1500
of urea at flowering stage 1 hour @ Rs. 10/Kg
Rs. 100/hour
3.Threshing and cleaning required 2 200 b. 3.Decrease cost at 1st single 100
hours @ Rs. 100/hour dose application required
1 hour @ Rs. 100/hour

4. Marketing of 1 qtl of added wheat 100

yield required 1 hour @ Rs.
100/hour
b. Decrease in return Nill
A. Tatal (a+b) 500 B. Total (a+b) 11600

Net gain = B-A = 11600-500= 11,100

Complete budgeting
• Also called total budgeting.
• Complete budgeting refers to making out a plan for the farm as a whole.
• It considers all the crops, livestocks, method of production and aspects of marketing in consolidated
form and estimates cost and returns for farm as a whole.
• Required when farm plan is prepares for new farm or when drastic changes are suggested in existing
plan.
• It considers complementary, supplementary and competitive relationships between enterprise.
Partial budgeting Complete budgeting
It always treats minor change It accounts for a drastic change in the organization of an
operation of a farm.
Only consider a few, generally two alternatives All the available alternatives are considered in complete
budgeting.
It only helps for studying net effect in terms of costs and It is used for estimating the results of entire organization and
returns or relatively minor change operation of a farm.

Variable costs are considered for working out costs and Both fix and variable cost are are considered for working out
returns. cost and returns.
It is simple, easy and quick It is complex, tedious and takes more time for full budgeting
BASIC STEPS IN FARM PLANNING AND BUDGETING
I. Resource inventory:
• The development of whole plan is directly dependent upon an accurate inventory of available resources.
• The type and quality of resources available determine the inclusion of enterprise in whole farm plan.
1) Land: Land resource should receive top priority when completing the resource inventory. It is one of the
fixed resources. The following are some of the important items to be included in land inventory
a) Total number of acres available
b) Soil types ( slope, texture, depth)
c) Soil fertility levels.
d) Water supply or potential for developing an irrigation system.
e) Drainage problems and possible corrective measures.
f) Existing soil conservation practices
g) Existing and potential pest and weed problems which might
affect enterprise selection and crop yields.
h) Climatic factors including annual rainfall, growing seasons etc.
2) Buildings: Listing of all farm buildings along with their size, capacity and potential uses. Livestock
enterprises and crop storage may be severely limited in both number and size of the buildings available.
3) Labour: Labour should be analyzed for both quantity and quality. Quantity can be measured in man per
day .Determination of family members and hired labour. Any special skills, training and experience
should be noted.
4) Machinery: It is also a fixed resource. The number, size and capacity of the available machinery should
be included in the inventory.
5) Capital: The farmer’s own capital and estimate of amount which can be borrowed represent the capital
available for developing whole farm plan.
6) Management: The assessment of the management resources should include not only overall
management ability but also special skills, training, strengths, weaknesses of manager. Good
management is reflected in higher yields and more efficient use of resources.
II. Identifying enterprises: Based on resource inventory, certain crop and livestock enterprises will be
feasible alternatives. Care should be taken to include all possible enterprises to avoid missing enterprise
with profit potential. Custom and tradition should not be allowed to restrict the list of potential
enterprises.
III. Estimation of co-efficients : Each enterprise should be defined on small unit such one acre or hectare
for crops and one head for livestock. The resource requirements per unit of each enterprise or the
technical coefficients must be estimated. The technical coefficients become very important in
determining the maximum size of enterprise and the final enterprise combination.
IV. Estimating gross margins :
A gross margin is estimated for a single unit of each enterprise. Gross margin is the difference between
total income and total variable costs. Calculation of gross margin requires the farmer’s best estimate of
yields for each enterprise and expected prices for the output. The calculation of total variable cost
requires a list of each variable input needed, the amount required and the price of each input.
V. Developing the whole farm plan: All information necessary to organize a whole farm plan is now
ready for use. The systematic procedure to whole farm planning is identifying the most limiting resource
and selecting those enterprises with greatest gross margin per unit of resource.
Gross _ m arg in
• Returns per unit of resource = Unit _ of _ resource _ required

• Land will generally be a limiting resource and it provides a good starting point. At some point in the
planning procedure, a resource other than land may become more limiting and emphasis shifts to
identifying enterprises with greatest return or gross margin per unit of this resource.
Steps in Farm Planning and budgeting (Fundamental of farm business management)
Following steps need to be followed in developing optimum farm plan with budgeting.
1. Specification of the technical co-efficient of production: Specifying the requirements of each resource in
producing each output.
2. Specification of appropriate prices- last year’s average price and future expectations.
3. Preparation of enterprise profitability chart- net return figures of all possible enterprises.
4. Preparation of the farm plan- including all physical features such ad soil types, topographical features,
drainage, roads, water canals, source of irrigation, bulidings etc.
5. Inventory preparation- complete list of farm resources such as land, labor, bulildings, machinary, liquid
capital etc.
6. Examine the existing farm plan- work out on the variable costs, gross income and net income of each
enterprise
7. Locate the weakness of the present plan
8. List out the risks to agricultural production on that farm
9. Prepare the alternative plans
10. Analysis of the alternative plans
11. Implementing the plan
Techniques of farm planning and budgeting
Production planning- planning for production activities on a farm
Organizational planning- coordination, relationship, job descriptions etc.
Administrative planning- human resource management, procurement and management of physical resource
etc.
Financial planning- cash flow analysis, accounting, auditing etc.
Marketing planning- demand supply analysis, marketing research, market information system etc.
Practical
Title- To prepare enterprise budget and partial budget of agricultural farm.
Objectives
To know about types of budgeting
To be able to prepare enterprise and partial budget.
Theory
Conclusion
 Farm records and accounts
• Concept of farm records and accounts and their advantages; types of farm records: physical
and financial records
• Farm inventory: concept, advantages and process of taking inventory
• Methods of valuation and depreciation calculation
• Balance sheet, income statement and cash flow statement
Definition
• Irrespective of the method of farm planning, reliable and accurate data are necessary to narrow down the gap
between planning and best performance.
• Farm record is record of all activities and transactions regarding all aspects of farm operation.
• Farm accounting is analysis of farm records for the purpose of determining assests and financial situation of
farm at particular time.
• Farm record and account gives information on Input-Output Relations, inputs availability, assurance of
marketing, soil fertility for crop allocation, etc. for improving the performance of farm.
• As a rapid development in agriculture and development of computer package for record keeping and feed
formulation, a systematic and accurate farm records is helpful for the projection of successful plan and
program.
• In developed countries, farm recording is in advance stage, whereas in most of the developing countries
farmers have no formal recording system.
Importance of farm record and account
1. It gives informations of what happens in the farm from the beginning to the end of the farm business.
2. Provides the necessary facts and figures for farm planning and budgeting.
3. It helps to determine the level of profit or loss made by the farm.
4. It enables the farmers to obtain loans from the bank.
5. It creates room for farm evaluation in order to determine the farmer’s management skills- net worth statement,
profit-loss statement; the cash flow statement.
6. The actual yield of the farm can be determined.
7. It enables tax inspectors to accurately asses the farm and know the total tax to be paid.
8. Certain decisions relating to the farm can be taken in order to facilitate long term planning.
9. It also enables the farmer to keep abreast with all the activities in the farm.
10. Basis of conducting research in Agricultural Economics and production economics.
11. Basis for government policies.
Problems in Farm Accounting
1. Subsistence nature of farming – Farmers does not engage separately trained accountants for helping them in
farm accounting.
2. Farming is a laborious work - At the evening farmer get exhausted by all day long physical labour and
mental work and does not feel like sitting at the desk to complete record and account.
3. Triple role of Nepalese farmer – manager, financer and labourer.
4. Illiteracy and lack of business awareness.
5. Complicated nature of the agricultural business- biological industry and is always subject to weather and
other natural uncertainities.
6. Inadequate extension service- Sufficient number of trained specialists in farm management are not available
who could help farmers to maintain account of their business.
7. Non-availability of suitable farm record books.
8. Fear of taxation.
Characteristics of good farm records and accounts
• Simple and easy to understand.
• Suitable form for recording the type of information farmer wants to record.
• Provision for an itemization and classification of all entries.
• Adequate space for itemization of all entries and the lines and space sufficiently wide for writing without
crowding.
• Ample space for each section for all the entries that are likely to be recorded.
• Adequate instructions for recording and analysis of recorded data.
Accounting period
• Different accounting periods are adopted by various business , according to their various needs and
convenience.
• In general business companies and government consider one year period from Shrawan to Ashadh (fiscal year
year peroid).
• July 16 to July 15.
Types of farm recording systems
A good farm record system enables recording informations that farmer needs and permits desired analysis of
information recorded.
I) Farm inventory
II) Farm financial accounting
III) Farm cost accounting
a) Full cost accounting
b) Single enterprise accounting
i) Farm inventory
• List of the physical properties (assests) along with their value that the farm owns at a particular date.
• Assests here refers all materials owned by the farmer and used in production process.
• Land, building, machinary, livestocks record, poultry record, record of standing crops, stock sales
volume, etc. where farmer record physical quantity.
• Inventories are generally taken twice a year – at the beginning and at end of the year.
Reasons for preparing farm inventory
• A complete farm inventory, taken at a specific date, gives a list of all these assest with their values. It shows
what amount of capital is accumulated in the business.
• Helps to work out last year take over and this year left over.
• Shows change in networth through the comparision of inventories taken at the beginning of the year with
another taken at the end of the year. It acts as basis for computing growth in net worth.
• It enables farmers to work out measure of income.
• Helps to determine the depreciation cost.
• Basis for income statement
All the physical assets divided into three types:
Non depreciable assets:
For ex: grains ready to sale, produced goods, FYM, compost, insecticide, growing crops in the field, fodder
and feed, pesticides, fungicides, milk, poultry, egg etc. are marketable livestock assets.
Depreciable assets:
Farm machinery, rice harvestor cum thresher, drillers and other equipments, spade, sickle, farm buildings, land,
dairy cattle, bullock, etc.
Cash assets:
Cash on hand, deposit, share from co-operatives and bank etc.
Process for preparing farm inventory
There are two steps involved in preparing farm inventory.
Examination of physical assests- includes listing of farm assests like land, buildings, fences, equipment,
livestock, supplies etc. It is necessary to verify the numbers and measurement like weight(kg), area(ha) etc.
Valuation of physical assests-
Each of the listed item should be valued using an appropriate valuation method.
a) Valuation at cost or market price: Valuation is estimated at the market price or cost which ever is lower.
For example for valuing purchased farm supplies such as seed, fertilizers, pesticides, insecticides, etc.
• Valuation of asset = Valued at Cost or Market price which ever is lower.
b) Valuation at net selling price: This means the price which could probably be obtained for the asset if
marketed, less the cost of marketing/selling.
• Valuation of asset = Value at Net Selling Price i.e. at the market price (less the selling cost)
• This conforms more closely top resent worth. This method is used for those items that are held primarily for
sale like milk, livestock ready to sell in the market.
c) Cost minus depreciation: With cost as the basis of valuation, the inventories show the total of sums actually
put into the business (purchase price) and amount depreciated over time. This method is very accurate for
working assets that is farm machinery, breeding animals.
d)Valuation by reproductive value or replacement cost minus depreciation : This method is to value the
assets at what cost to reproduce them at present prices and under present methods of production. This method is
best suited for long-lived assets such as farm buildings.
• Valuation of asset = Valued the assets at what it would cost to reproduce them at present prices and under
present methods of production–Depreciation
• Used for valuation of long-lived asset.e.g. Building, machinery, equipments
e)Income capitalization methods: V=R/r
• This method is appropriate for the farm assets whose contribution to the income of the farm business can be
measured over many years and which have along life.
Where, V = Value in Rupees, R = constant income over infinite number of years in future and r=Rate of
interest.
• Used for valuation of long lived farm assets contributed in farm business income e.g. Land
 Farm Inventory of Singh Farm on 1st July 2019 and 30 June 2020
S.N Items Beginning of the year (1-7-2019) End of the year (30- 6- 2020)

Quantity Value Quantity Value

1 Non- Depreciable assets

a) Crop produced
b) Seed
c) Fertilizers
Sub Total
2 Depreciable assets
a) Farm Machinery
b) Farm building
c) Livestock
d) Land
Sub Total
3 Cash Assets
a) Cash in hand
b) Bank deposits
Sub total
Grand Total
Change in Inventory
a) Beginning total
b) Closing Total
c) Change = a-b
ii) Financial accounting
• Records and accounts relate to the operations and activities of farm business as a whole.
• It shows aggregate effect of all the farm undertakings such as crop growing, dairy, poultry etc.
• Expenditure incurred is not shown separately in each enterprise separate account.
• At the end of the year, profit and loss account and balance sheet is prepared.
• Shows over all picture of entire business.
iii) Cost accounting
a) Full cost accounting
• Shows income and expenditure and profit and loss of farm business as a whole as well as for each
department, ,enterprise or each product as a separate unit.
• A profit or loss in each enterprise as well as the farm as a whole and balance sheet of entire business at the
end of the year are prepared.
b) Single enterprise accounting
• Accounts are kept for important selected enterprise or a particular aspect of an enterprise such as in milk
production, crops, egg etc
• This method is simple and takes less time.
System of book keeping
• System of record written to furnish a history of farm business transaction with special reference to financial
side.
• There are two systems of farm accountancy
i) Double entry system
• Two entries are made for each transaction in the same book, one being a debt entry and the other a credit
entry.
• Every business transaction involves two parties- one for receiving the good and service and other giving
them.
• Example- Sale of wheat for Rs.240
Here two account involved will be cash account and wheat account. Cash account will be receiving
account and hence the amount will be will be written on debit side. Wheat account will be the giving
account ,hence the amount will be written on credit side .
• Let's assume that a company borrows $10,000 from its bank. The company's Cash account must be increased
by $10,000 and a liability account must be increased by $10,000. To increase an asset, a debit entry is
required.. Hence, the account Cash will be debited for $10,000 and the liability Loans Payable will be
credited for $10,000.
ii) Single entry system
• This system ignores the double effect of transactions.
• Personal accounts of debtors and creditors are kept separately.
• This is relatively imperfect.
Depreciation
• It represents the amount by which a farm resource decreases in value, as a result of cause other than a
change in the general price of the item.
• Depreciation is defined as decline in the value of a given asset as a result of use, tear, accidental and time
obsolescence.
• Depreciation involved prorating the original cost of an asset over its useful life.
• Computation of depreciation would not be necessary if all items purchased were completely worn out by
the end of each year.
• It is used on items which are used over larger numbers of years like buildings, equipment, livestock etc
and an important question arises about determination of cost of such articles for one specific year.
Methods of calculating depreciation
The most common methods of computing depreciation are:
1. Annual revaluation
2. Straight line method
3. Diminishing balance of method
4. Sum of the year digits or reproducing fraction method
1. Annual Revaluation: This is the yearly valuation of assets. This method implies estimating the market value
of the asset in the beginning and the end year inventory and then taking the difference as depreciation.
• Commonly used for livestocks.
2. Straight line method: This method is easy, simple and usually most satisfactory for various purposes.
• This methods is more useful for durable assets like building, fences that require uniform maintenance during their
life time.
• This method assumes that assets are use more or less to same extent every year and therefore equal amounts of
cost on account of their use can be charged every year.
• From this method, the annual depreciation of assets is computed by dividing the original cost of the assets less
junk value by the expected year of life.
D=(OC-JV)/EL
Where, D = Depreciation
OC = Original Cost
JV = Junk value
EL = Expected Life
• Junk value- Junk value is the value of the asset at the end of its useful life.
• Junk value also called residual value or scrap value or exhausted value or salvage value or terminal value.
• For ex: machinery : purchase price = Rs 1,000,000 expected life = 10 years ,junk value after 10 years would be
Rs.100,000.
Then, depreciation=(1,000000-100,000)/10
= 900,000/10
=Rs.90,000
• Information about useful years of particular asset can be obtained from engineers and for second hand machine
one can make personal estimates.
• Not suitable for assets that get used up at varying rate. Eg tractor depreciate much more during first few years
than in later years.
3.Diminishing balance method:
• According to this method, fixed rate depreciation is used every year and applied to the remaining value assets at
the beginning of each year.
• Fixed rate is applied to the balance until the salvage value is reached and no further depreciation is possible.
• This method results in higher depreciation charge during the early life of item and lower charge in later years
and provides automatically for the salvage value at the end of the period.
• This method assumes depreciation is at a fixed percentage every year however, the depreciation amount
decreases throught the year.
• For example- a machine of value Rs1,000,000 is depreciated at 20% then depreciation in first year is
200,000 and that in second year 160,000 (that is 20% of 1,000,000-200,000)
• Annual depreciation is calculated by this method at the rate of 20% for machine costing NRs. 1,000,000 and
salvage value NRs 100,000. The results can be as:

Value at the beginning of year Annual depreciation Remaining balance

1st year NRs.1,000,000 20% of NRs 1,000,000- NRs

NRs.1,000,000=NRs200,000 200,000=NRs.800,000
2nd year NRs.800,000 20% of NRs.800,000= NRs. 800,000- NRs 160,000=NRs
NRs.800,000= NRs.160,000 640,000
3rd year…….
4th year……
The calculation goes on taking
20% of remaining until the
salvage value(NRs.100,000) is
reached.
4. Sum of the year digits or reducing fraction method:
• The depreciation of assets distributes heavily in first year of use and more lightly in later years.
• Sum of year digits method has some advantage over diminishing balance method because there is no
undistributed balance is left over.
• The following formula is used for calculating the annual depreciation
• AD = F*AMD
Where,
AD = Annual Depreciation
F = Fraction for any year
AMD = Amount to be depreciated
F = RM/SYM
Where,
F = Fraction for any year
RM = Year of remaining life at the beginning of account period
SYM = Sum of the years of life of the asset
• Example, F (1st year) = 10/(1+2+3+4+5+6+7+8+9+10)=10/55
• F (2nd year)=9/(1+2+3+4+5+6+7+8+9+10)= 9/55
• Amount to be depreciated=(Purchase price of Asset – salvage value)
Consideration in Calculating Depreciation
1.The life of many machines is often longer than the normal expectations used in estimating the
depreciation. The farmers therefore need to make suitable adjustment through time by adjusting the
actual condition of the implements.
2.In case of minor repair, use of oil and lubrication, etc. normally no extra depreciation is charged.
However, machines are reconditions or buildings are repaired or remodeled to an extent to
appreciably increase their value within the accounting year, the closing inventory should recognize
the change. A convenient procedure is to add the cost of the repairs to the existing value of the asset.
3. In case of small tools, they are considered to be used up within one year. Assume 100% depreciation
on them.
4. If machine is purchased as second hand, the number of the years it has been used and the original
price may not be known, the logical procedure in this case is to estimate the remaining years of its
life and begin depreciation on the purchase price.
5. When the livestock is in breeding stage or appreciation phase, revaluation method will be more
useful. But, when they start depreciating say after 3rd year, in case of bullocks, straight-line would
be appropriate.
• Ex. Suppose a tractor cost Rs.24,000 and expected to last 10 years. The junk value of tractor after 10 years
would be Rs.4,000 and has depreciation rate of 20 % per year. Calculate depreciation using various methods.
1)Annual revaluation
In this case depreciation cannot be calculated by annual revaluation as tractor value at the end of the year is not
given.
2)Straight line method
= (Original cost – Junk value)/ expected life
= (24,000- 4000)/10
= 20000/10
= Rs. 2000 per year.
3) Diminishing balance method

8th year Rs 5033.17 (20% of Rs 5033.17) (Rs 5033.17-1006.6)

= Rs 1006.6 =Rs.4026.5
9th year Rs. 4026.5 (20% of Rs 4026.5) (Rs.4026.5- 805.3)
= Rs. 805.3 = 3221.2
Sum of year digit method
AD = F*AMD
Where,
AD = Annual Depreciation
F = Fraction for any year
AMD = Amount to be depreciated
Comparison of annual depreciation by using different method
Practical
Title-Calculation of annual depreciation using different methods.
Q. Calculate annual depreciation of a power tiller worth Rs 24,00,000 at present, salvage value Rs.
2,00,000,depreciation rate 20% and useful life 12 years using different methods.