- - AGRICULTURAL CORE CURRICULUM - - (CLF1000) Advanced Core Cluster: AGRICULTURAL BUSINESS MANAGEMENT (CLF1200) Unit Title: Economic Principles ____________________________________________________________________________ (CLF1203) Topic: PHYSICAL PRODUCTION Time Year(s) RELATIONSHIPS, VALUES, 3 hours 3 /4 AND PROFIT MAXIMIZING LEVEL OF INPUT USE ____________________________________________________________________________ Topic Objectives: Upon completion of this lesson the student will be able to: Learning Outcome #: (E-7) - Use economic decision-making tools to increase the profitability of agricultural enterprises. (E-8) - Describe the concept of diminishing returns. Special Materials and Equipment: SUPPLEMENTAL WORKSHEET 1 PHYSICAL PRODUCTION RELATIONSHIPS SUPPLEMENTAL WORKSHEET 1 INSTRUCTOR KEY SUPPLEMENTAL WORKSHEET 2 PHYSICAL PRODUCTION GRAPH SUPPLEMENTAL WORKSHEET 2 INSTRUCTOR KEY SUPPLEMENTAL WORKSHEET 3 COST AND VALUE OF HIRING ADDITIONAL EMPLOYEES SUPPLEMENTAL WORKSHEET 3 INSTRUCTOR KEY References: Leftwich, R. H. (1976). THE PRICE SYSTEM AND RESOURCE ALLOCATION (6th ed.). Hinsdale, IL: Dryden Press. Evaluation: Unit Exam TOPIC PRESENTATION: PHYSICAL PRODUCTION RELATIONSHIPS, VALUES, AND PROFIT MAXIMIZING LEVEL OF INPUT USE A. Physical Production Relationships 1. Physical production relationships underlie all economic production decisions. 2. A production function describes the physical relationship between the quantities of inputs and the quantities of product that result. a. A production function may be represented as a table or a graph. b. A simple production function with one variable input (as in Worksheet 1) assumes that all other production inputs remain constant. 3. Total Physical Product (TPP) is the total quantity of output resulting from each level of input use. a. As the amount of a variable input increases (as other inputs remain constant), TPP first increases, then decreases, and may eventually become negative. This is what is meant by diminishing returns in production. 4. Average Physical Product (APP) is the quantity of output produced per unit of input at each level of input use. a. APP equals total output divided by the number of units of input. b. APP is commonly referred to as "yield." 5. Marginal Physical Product (MPP) is the quantity added to total physical product when another unit of input is used. a. MPP is the slope of the production function. b. As additional units of input are added, MPP eventually decreases. This is what is meant by diminishing marginal returns in production. _________________________________________________________ ACTIVITY: 1. Complete SUPPLEMENTAL WORKSHEET 1, Physical Production Relationships. Graph these relationships onto SUPPLEMENTAL WORKSHEET 2, Additional Employee Graph. Use these worksheets to demonstrate and explain relationships between TPP, APP, and MPP. _________________________________________________________ B. Stages of Production 1. Stage I is any input level less than that which yields maximum APP. It would be irrational to limit the use of an input as long as a greater APP can be achieved from an increase in its use. a. As long as MPP is greater than APP, APP is increasing. b. When MPP is less than APP, APP is decreasing. c. APP is at a maximum when it is equal to MPP. d. Stage I can be graphically identified to the left of the intersection of APP and MPP. 2. Stage II identifies a rational range of input usage. It is the area between maximum APP and maximum TPP. 3. Stage III, is any input level beyond that which yields maximum TPP. It is irrational to use a level of input which decreases the TPP. a. When TPP is at a maximum, MPP equals 0. b. At any input level beyond maximum TPP, MPP is negative. c. The beginning of Stage III can be graphically identified to the right of the point where MPP equals 0. 4. Rational production takes place in Stage II of the production function. The price of the product and the input cost will determine where in Stage II to produce. _________________________________________________________ ACTIVITY: 1. Identify the Stages of Production on SUPPLEMENTAL WORKSHEET 2, Physical Production Graph. _________________________________________________________ C. Value Relationships - TVP, AVP, MVP, and MFC 1. In order to determine the level of input use which maximizes profit, not only physical production relationships must be considered, but also the cost of production and the value of production. 2. Value of Production a. Total Value Product (TVP) is the total value of output produced at each level of variable input use. TVP = TPP X Price of the Output b. Average Value Product (AVP) is the value of output per unit of input for each level of variable input use. AVP = TVP / Units of Input Used c. Marginal Value Product (MVP) is the amount added to total value product when another unit of the variable input is used. MVP = Change in TVP / Change in Units of Input Used 3. Input Cost a. Marginal factor cost (MFC) is the amount added to total cost when one more unit of a variable input is used in production. b. If the unit price of the input remains the same, regardless of how much of the input is used: MFC = Price of One Unit of the Variable Input _________________________________________________________ ACTIVITY: 1. Complete SUPPLEMENTAL WORKSHEET 3, Cost and Value of Hiring Additional Employees. _________________________________________________________ D. Profit Maximizing Level of Input Use 1. Profit (net returns) will be maximized when the MVP = MFC. a. At the level of resource use that equates the marginal value product (MVP) with the marginal factor cost (MFC), an additional unit of the variable input adds to revenue just what it adds to costs. _________________________________________________________ ACTIVITY: 1. Identify the profit maximizing level of hired labor on SUPPLEMENTAL WORKSHEET 3, Cost and Value of Hiring Additional Employees. _________________________________________________________ E. Summary 1. The profit maximizing level of input to use is determined by both underlying physical production relationships and the price of both the input and the output. 2. Profits are not necessarily maximum when the total physical product is greatest. 3. Profits are not necessarily maximized when the physical return per unit of input (yield or APP) is greatest. _________________________________________________________ ACTIVITY: 1. Verify these last two assertions by reference to SUPPLEMENTAL WORKSHEET 3, Cost and Value of Hiring Additional Employees. _________________________________________________________ SUPPLEMENTAL WORKSHEET 1 - PHYSICAL PRODUCTION RELATIONSHIPS Determine the average product and marginal product. No. of Trees Workers Planted TPP APP MPP ============================================ 1 10 2 22 3 36 4 49 5 60 6 66 7 70 8 68 TPP = total physical product APP = average physical product MPP = marginal physical product SUPPLEMENTAL WORKSHEET 1 - PHYSICAL PRODUCTION RELATIONSHIPS - INSTRUCTOR KEY Determine the average product and marginal product. No. of Trees Workers Planted TP AP MP ============================================ 1 10 10 xx 2 22 11 12 3 36 12 14 4 49 12.25 13 5 60 12 11 6 66 11 6 7 70 10 4 8 68 8.5 -2 TPP = total physical product APP = average physical product MPP = marginal physical product SUPPLEMENTAL WORKSHEET 2 - PHYSICAL PRODUCTION GRAPH Graph the total physical product, average physical product and marginal physical product curves. | | | | | | |__________|__________|__________|__________|__________|__ | | | | | | | | | | | | T | | | | | | R | | | | | | E 80 |__________|__________|__________|__________|__________|__ E | | | | | | S | | | | | | | | | | | | P | | | | | | L 60 |__________|__________|__________|__________|__________|__ A | | | | | | N | | | | | | T | | | | | | E | | | | | | D 40 |__________|__________|__________|__________|__________|__ | | | | | | | | | | | | | | | | | | | | | | | | 20 |__________|__________|__________|__________|__________|__ | | | | | | | | | | | | | | | | | | | | | | | | |__________|__________|__________|__________|__________|__ 1 2 3 4 5 6 7 8 E M P L O Y E E S H I R E D SUPPLEMENTAL WORKSHEET 2 - PHYSICAL PRODUCTION GRAPH - INSTRUCTOR KEY Graph the total physical product, average physical product and marginal physical product curves. T | | | | | | | R |__________|__________|__________|__________|__________|__ | | | | | | E | | | | | | | | | | | | E | | | | | | 80 |__________|__________|__________|__________|__________|__ S | | | | | | | | | | | | | | | | TP | | | | | TP TP | P 60 |__________|__________|____TP____|__________|__________|__ | | | | | | L | | | | | | | | TP | | | A | | | | | | 40 |__________|__________|__________|__________|__________|__ N | | TP | | | | | | | | | | T | | | | | | | TP | | | | E 20 |__________|__________|__________|__________|__________|__ | | MP | | | | D | APMP AP APMP AP | | | | TPAP | | MP AP AP | | | | | MP MP AP | |__________|__________|__________|__________|__________|__ 1 2 3 4 5 6 7 8 MP E M P L O Y E E S H I R E D Connect TP's for total physical product curve. Connect MP's for marginal physical product curve. Connect AP's for average physical product curve. Note: These locations are marked approximately. SUPPLEMENTAL WORKSHEET 3 - COST AND VALUE OF HIRING ADDITIONAL EMPLOYEES 1. The market price per tree is $15. The cost of hiring each additional employee is $120. Complete the following table. No. of Trees Workers Planted TPP APP MPP TVP AVP MVP MFC =============================================================== 1 10 2 22 3 36 4 49 5 60 6 66 7 70 8 68 TPP = total physical product APP = average physical product MPP = marginal physical product TVP = total value product AVP = average value product MVP = marginal value product MFC = marginal factor cost 2. HOW MANY EMPLOYEES SHOULD BE HIRED? __________________ SUPPLEMENTAL WORKSHEET 3 - COST AND VALUE OF HIRING ADDITIONAL EMPLOYEES - INSTRUCTOR KEY 1. The market price per tree is $15. The cost of hiring each additional employee is $120. Complete the following table. No. of Trees Workers Planted TPP APP MPP TVP AVP MVP MFC ================================================================= 1 10 xx xx $ 150 $ 15 $ 150 $ 120 2 22 11 12 330 165 180 120 3 36 12 14 540 180 210 120 4 49 12.25 13 735 183.75 195 120 5 60 12 11 900 180 165 120 6 66 11 6 990 165 90 120 7 70 10 4 1050 150 60 120 8 68 8.5 2 1020 127.50 $-30 120 TPP = total physical product APP = average physical product MPP = marginal physical product TVP = total value product AVP = average value product MVP = marginal value product MFC = marginal factor cost 2. HOW MANY EMPLOYEES SHOULD BE HIRED? 5 EMPLOYEES Beyond this level of input (employees), the value of marginal production (MVP) no longer covers the marginal cost of production (MFC). 12/2/91 LM/GB/sg #%&C