ECONOMICS OF

AGRICULTURAL PRODUCTION
(AGR553)
CHAPTER 4
COSTS, RETURNS AND
PROFITS ON THE OUTPUT
SIDE
Chapter Outline
🞂Some Basic Definitions
🞂Simple Profit Maximization from
the Output Side
🞂The Duality of Cost and Production
🞂The Inverse of a Production
Function
🞂Linkages Between Cost and
Production Functions
🞂The Supply Function for the Firm
(AGR553)
Costs
🞂 Total Fixed Cost (TFC)
🞂 Average Fixed Cost (AFC)
🞂 Total Variable Cost (TVC)
🞂 Average Variable Cost (AVC)
🞂 Total Cost (TC)
🞂 Average Total Cost (ATC)
🞂 Marginal Cost (MC)

AGR553 3
Cost Concepts
These seven costs are output related.

Marginal cost is the cost of producing an

additional unit of output.

The others are either the total or average

costs for producing a given amount of
output.

AGR553 4
Short Run and Long Run

The short run is the period of time during

which the quantity of one or more
production inputs is fixed and cannot
be changed.

The long run is the period of time in which

the amount of all inputs can be changed.

AGR553 5
Fixed Costs
🞂 Fixed costs exist only in the short run.
🞂 In the short run, fixed costs must be
.
paid regardless of the amount of
output produced.
🞂 Fixed costs are not under the control
of the manager in the short run.

AGR553 6
Example of Fixed Costs

The example of fixed costs are

depreciation, interest, property taxes
and insurance are example of fixed
costs.
Some repairs may be fixed costs, if
they are for maintenance. In practice,
machinery repairs are usually counted
as variable costs, while building
repairs are counted as fixed.
AGR553 7
Computing Total Costs
🞂 Total Fixed Cost (TFC): The sum of all
fixed costs
🞂 Total Variable Cost (TVC): The sum of
all variable costs
🞂 Total Cost (TC) = TVC + TFC

AGR553 8
Average and Marginal Costs
🞂 Average Fixed Cost (AFC): TFC/Output
🞂 Average Variable Cost (AVC):
TVC/Output
🞂 Average Total Cost (ATC or AC):
TC/Output
🞂 Marginal Cost: ΔTC/ ΔOutput or
ΔTVC/ ΔOutput

AGR553 9
Typical total cost curves

AGR553 10
Average and marginal cost curves

AGR553 11
Things to Notice
🞂 AFC always decreases
🞂 MC may decrease at first but it
eventually must increase
🞂 AVC and ATC are typically U-shaped
🞂 MC=AVC at minimum point of AVC
🞂 MC = ATC at minimum point of ATC
🞂 ATC approaches AVC from above

AGR553 12
Illustration of Cost Concepts Applied to a
Stocking Rate Problem

AGR553 13
Graph of ATC, AVC, MC and AFC
from Stocker Problem

ATC MC

AVC

AFC

AGR553 14
Application of Cost Concepts

Cost concepts can be used in both

short and long-run decision
making.

AGR553 15
Production Rules for the Short
Run
🞂 If Price > ATC, produce and make a
profit.
🞂 If ATC>Price>AVC produce and
minimize losses.
🞂 If AVC> Price, do not produce and limit
your loss to your fixed costs.

AGR553 16
Logic behind These Rules

• Fixed costs must be paid whether you

produce or not in any given year.
• They are therefore irrelevant to the
production decision.
• You look at variable costs.
• If you can cover those, you should
produce.
• If you can’t, you don’t produce.

AGR553 17
Producing at a Loss Example
Fixed Costs are $10,000. At the point where
MR=MC, TVC are $8,000 and TR is $12,000.

If I don’t produce, I will have a loss of _______

$10,000
If I do produce, I will have a loss of $6,000
_________

I should produce to minimize losses.

AGR553 18
If Losses Exceed Fixed Costs

Fixed Costs are $10,000. At the point where

MR=MC, TVC are $15,000 and TR is $12,000.

If I don’t produce, I will have a loss of _______

$10,000
$13,000
If I do produce, I will have a loss of _________

.
I should not produce

AGR553 19
🞂 Fixed Costs are $150,000. At the point
where
🞂 MR=MC, TVC are $160,000 and TR is
$200,000.

🞂 Should the company produced? Why?

Illustration of short-run production decisions
: Supply curve function

AGR553 21
Don’t Produce: Graphical
View
ATC

AVC

loses more than

fixed cost
MR =
Price
MC
Outpu
t
AGR553 22
Produce at a Loss: Graphical
View
ATC
loses less
AVC than
fixed cost

MR =
Price

MC
Outpu
t
AGR553 23
Produce at a Profit: Graphical
View
ATC
per-unit
profit
AVC
MR =
Price

MC
Outpu
t
AGR553 24
Production Rules for the Long
Run
🞂 Price > ATC. Continue to produce at
the point where MR=MC.
🞂 Price < ATC. Stop production and sell
fixed assets.

AGR553 25
 ECONOMIC
COSTS Costs or
Economic
Opportunity Costs
Forgoing the opportunity to
produce alternative goods
and services

Explicit Costs
Implicit
Economic Costs
🞂 Costs exist because resources are scarce
and productive and have alternative uses.

🞂 An economic cost, or opportunity cost, is

the value of the best alternative use of a
resource.

🞂 From the firm’s perspective, an economic

cost is the payment it must make to
attract the resources it needs away from
alternative production opportunities.
Explicit and Implicit Costs
🞂Payments to resource suppliers are
explicit or implicit.
◦Explicit costs are the monetary
payments a firm must make to an
outsider to obtain a resource.
◦Implicit costs are the monetary
income a firm sacrifices when it uses a
resource it owns rather than supplying
the resource in the market.
 ECONOMIC
COSTS
Economic or Pure
Profits
Economi Total
Economic
c Revenu
Cost
Profit e
 ECONOMIC
COSTS
Profits to an Profits to an
Economist Accountant
T
Economic (opportunity) Costs

Economic O
T
Profit A Accounting
Implicit costs L Profit
(including a
normal profit) R
E
V
Explic Accounting
E
costs (explicit
it N
U costs only)
Costs
E
SHORT RUN AND LONG RUN
Accounting:
Short and long run is based
upon annual chronology.
Economics:
Short run has fixed plant
capacity size.
Long run has variable plant
capacity size.
Short Run and Long Run
🞂 When the demand for a firm’s product
changes, it must adjust the amount of
resources it employs.
🞂 Some firms can easily adjust the
quantities of certain resources it uses,
while other may need more time.
◦ Because of these differences in time
adjustments, economists distinguish
between two time periods: the short
run and the long run.
Short Run and Long Run
🞂 The short run is a time period in
which producers are able to change
the quantities of some but not all of
the resources they employ.
◦ A firm can adjust the number of workers
but not the plant’s capacity in the short
run.
🞂 The long run is a time period
sufficiently long to enable producers to
change the quantities of all the
resources they employ.
SHORT-RUN PRODUCTION COSTS
Summary of
Definitions
Total Fixed Costs = TFC
Total Variable Costs = TVC
Total Costs = TC
Average Fixed Costs = AFC
Average Variable Costs = AVC
Average Total Costs = ATC
Marginal Cost = MC
 LONG RUN COST CURVE

Economies Constant returns Diseconomies

of scale to scale of scale
Unit Costs

long-run ATC

Output
THANK YOU..