Detailed explanations on the introductory part of livestock and crops production economics.

1. 1
AEA 201: Production Economics
Lecture: 45 HRS
Seminar: 30 HRS
Aggr. Wt: 60 HRS
Credits: 2
Instructor: Prof. Reuben M.J. Kadigi
Email: rmjkadigi@sua.ac.tz

2. 2
New Credit Rating & Distribution
Credit Rating: 9 Credits
Time Distribution: Lectures 30 HRS
Tutorials 20 HRS
Practical 20 HRS
Assignments 10 HRS
Independent Study 10 HRS
Total 90 HRS

3. Course Objective:
At the end of the course students
should be able to apply
production economic principles in
analysing farm business
enterprises
3

4. Expected Leaning Objectives:
Upon successful completion of this course
students should be able to:
a) Understand some important concepts of production
economics, economic theories and modelling
b) Define production and cost functions
c) Understand the basic concepts of returns to scale
and its various aspects
d) Interpret and apply production economic principles
in analysing agribusiness enterprises to guide
decision making
4

5. 5
Course Content
1 INTRODUCTION
1.1 What is Economics?
1.2 Some Important Concepts in Economics
1.3 Economic Modelling
1.4 Types of Economics
1.5 Assumptions of Pure or Perfect Competition

6. 2 PRODUCTION FUNCTIONS
2.1 Important Concepts
2.2 Factor Product Relations
2.3 The Law of Diminishing Returns
2.4 Three Stages of Production
2.5 The Elasticity of Production
2.6 Forms of Production Functions
6

7. 7
3 COST FUNCTIONS
Derivation of Cost Functions from
Production Functions
4 INPUT MIX DECISIONS
(FACTOR-FACTOR
DECISIONS)
Relationship Between Inputs

8. 5 OUTPUT MIX DECISIONS
Revenue Maximizing Combination of Products
6 CONSTRAINED OPTIMISATION
7 LINEAR PROGRAMING
8 ECONOMIES OF SIZE/SCALE
8

9. Assignments
9

10. Assignment 1
Review the theories of
monopoly, monopsony,
monopolist competition,
oligopoly, perfect competitive
markets etc.,
Giving examples, write brief
notes on each type of these
markets 10

11. Assignment 2: A LP case study
 Visit the following Youtube websites and listen to the LP lectures:
https://www.youtube.com/watch?v=vVzjXpwW2xI
https://www.youtube.com/watch?v=MZ843Vvia0A
https://www.youtube.com/watch?v=RicajFzoenk
https://www.youtube.com/watch?v=d364PTot0j4
 After listening to these lectures follow the same steps to undertake a
case study of your own choice of agricultural commodity.
 Note: You are required to write a Term Paper which includes the
“answer report” and “sensitivity report”.
 Use the general format of a scientific report (which includes the results
and discussion section)
 Avoid free riding because your tests and final exam may contain some
questions which require a through understanding of this assignment
11

12. 12
Assessment:
1) Assignment 1 (10%)
2) Assignment 2 - Term Paper (TP)
(20%)
3) Test (20%)
4) UE (60%)

13. References
1. Rasmussen S. (2010). Production Economics: The
basic theory of production optimization. Institute
of Food & Resource Economics, University of
Copenhagen, 338 pp.
2. Doll J.P. and Orazen F. (1984). Production
Economics Theory with Applications. 2nd Edition,
John Winel & Sons, 470pp.
3. Debertin D.L. (1986). Agricultural Production
Economics, Second Edition. Macmillan, 413pp.
13

14. 1.1
What is Economics?
14
1.0 INTRODUCTION

15. 15
• The study of how limited resources can
best be used to fulfil unlimited human
wants
Wants and desires of human beings are
unlimited
The means/resources are limited
What is Economics? ...

16. 16
• Economics is concerned with
understanding the principles and
developing rules that govern the
production and consumption of goods
and services in an economy in order to
make the best use of available resources

17. Specifically, it deals with understanding
and modelling the behaviour of
individual consumers and producers as
well as the aggregate of all consumers
and producers
The set of rules governing behaviour
are represented as economic theories
17

18. 18
• A simplified representation of the complex
real world
• Widely accepted to be the set of
relationships governing the behaviour of
individual producers or consumers or the
set of relationships governing the overall
economy of the society or nation
An economic theory

19. May also represent a hypothesis or
proposition about how something
operates based on observation
Such hypotheses may be empirically
verified for their wider application
over time and space
19
An economic theory ...

20. 20
•Economic models
Can be used to test the validity of
economic theory in time and space
when answering the question “what
would happen if such and such a
change took place?

21. •Economic models may
be represented
Verbally
Graphically
Mathematically
21

22. 22
1.2
Some Important
Concepts
in
Economics

23. 23
• Scarcity
Important because most of goods
and services are scarce (including
production inputs and consumption
goods)
There are human needs/desires -
most of which are insatiable

24. Most resources are limited or
scarce
Abundant resources (e.g. air) are
free
Scarce resources are allocated
based on the price mechanism or
by rationing
24

25. 25
• Allocation
Because of scarcity and unlimited needs, a
mechanism must exist to guide the use of
resources
Choosing the best alternative which
reflects the real opportunity cost of the
resource
This is an alternative consistent with
individual or social objectives

26. Example:
A farmer must decide how much of
one hectare of land to allocate to
maize & sorghum
Prices play an important role in
the allocation
26

27. 27
• Goals (End or Objective)
The needs to be satisfied
Since individual needs/desires
appear to be unlimited, goals
compete for scarce resources
Economics helps to choose
among competing alternatives
by use of indicators

28. Examples of indicators ...
Prices for consumers and producers,
The profit motive - for producers
Utility in the case of consumers
The goal is often to maximise or
minimise these indicators
accordingly
28

29. 29
•Economic problem
Thus, for a problem to be
economic - scarcity &
alternatives must exist
If there is scarcity but no
alternatives, there is no choice to
be made

30. If there are alternatives but no
scarcity (the goods or resources
are free), the problem is not of
economic nature
In both examples allocation
would not solve the problem
30

31. 31
1.3
Economic Modelling

32. 32
• Relationships in the real world
are very complex
Assumptions are made to
understand the factors/causes &
effects of economic
relationships

33. An economic model may be ...
1) Descriptive (words)
Used since early periods of the
professions (18th Century)
Most early text describing economic
relationships are entirely descriptive
Example - Adam Smith’s “The Wealth
of Nations”
Was limited in its scope of addressing the
question what if a certain change was
introduced?
33

34. 34
2) Graphic
An improvement over verbal
representation, and had more
analytical capacity but limited in
the number of variables or factors
that could be represented
In two dimensions, therefore
limited to only two variable

35. 3) Mathematical
Capable of describing complex
economic theories and analyses
The advent of econometrics and
computers has made the application
of mathematical models even simpler
and more popular
35

36. 36
Example:
 The relationship between the price of a
product (PQ) and the quantity demanded (Q)
might be represented as follows:
a) Verbally: As the price increases, the quantity
demanded decreases

37. 37
Figure 1.2: Demand Model
PQ1
PQ2
Q1 Q2
b) Graphically

38. 38
c) Mathematically
Qi = f(Pi)

39. 39
1.4
Types
of
Economics

40. 40
Consumption Vs Production
economics ...
• Economics involves making
choices
With limited income the
choice is to buy items that
make one feel most satisfied

41. • Choice is central to consumption
economics
A person is said to derive utility
(satisfaction) from consuming the
good
The basic economic problem
involves maximisation of the utility,
subject to the constraint imposed by
the availability of income
41

42. 42
• The producer (firm owners) of goods
and services that are desired by
consumers is also faced by a set of
choices to be made
Is motivated by a desire to make
more money, in order to fulfil
unlimited wants
Also attempts to maximise utility

43. Although the producer may have
other goals, he/she frequently
strives to maximise profit as a
means of achieving utility or
satisfaction
Profits are subsequently used
to purchase other goods and
services that provide utility or
satisfaction to the producer or
firm owner
43

44. 44
Other producers may however
strive to maximise other goals (e.g.
amount of land owned, enterprise
size, type of machinery on their farm
- the latest)
Profit is often an overriding
(prime) goal among most farmers

45. 45
Microeconomics Vs
Macroeconomics ...
Traditionally economics
is categorised into:
Micro-economics
Macro-economics

46. Microeconomics ...
... is concerned with the behaviour of
individual decision making units,
i.e. individual consumers as they
allocate income or individual firm
managers or producers (e.g. a
farmer) as they allocate their
resources consistent with their goals
46

47. 47
... deals with the big picture i.e.
issues that confront the entire
economy
These issues include
inflation,
unemployment,
interest rates, and exchange rates (sometimes
called the macro-prices), and
money supply
Macroeconomics ...

48. 48
.... is also concerned with the role
of government policy in
determining fundamental
questions that must be answered
by any society
Macroeconomics ...

49. The fundamental
questions are:
What to produce
How much to produce
How should available
goods and services be
allocated 49

50. 50
• Although microeconomics &
macroeconomics are considered
separate branches of economics they
are actually closely related
The macro-economy is made of
individual consumers and producers
Their individual actions are reflected in
the aggregate depending on the
prevailing government policies

51. Static Economics
Vs
Dynamic Economics
51

52. 52
• Can be thought of as one or
more snapshot of events taking
place in an economy
a) Static Economics

53. Example: The economic
relationship represented by a
graph of market supply (SS) and
demand (D1D1) reflects a static
relationship at a point in time
53
Static Economics ...

54. 54
An event or
shock (e.g. an
increase in
income that
leads to
increased
demand) would
shift the
demand curve
from D1D1 to the
right (D2D2) Figure 1.2 Comparative Statics
P
D1
D1
D2
D2
S
S
(Old income)
(New income)
P1
P2
Q
1
Q2
b) Comparative
Static
This change is called comparative static

55. 55
Comparative static …
Is used in both microeconomic
and macroeconomic analyses
It is an intermediate between
static and dynamic economics

56. Does not consider:
The underlying cause of the income
change that leads to a shift in demand
The time interval between the two demand
schedules (timeless)
In static and comparative statics future
expectations are single valued
56
Comparative Static ...

57. 57
c) Dynamic economics
• Can be thought of as a moving
picture of the economy
• Time is important
• Attempts to show the process by
which an individual consumer, firm
or economy moves from one
equilibrium to another

58. • Examples:
Showing the path of machinery
investments made by a farmer
over a 20-year period,
Changes in the quantity of a
commodity demanded - one day,
week or month - from the time of
the price change 58
Dynamic economics ...

59. 59
d) Risk Vs Uncertainty
• They are an important part of
dynamic analysis
• Often future outcomes are not
known with certainty
• Thus they are multiple valued
rather than single valued

60. Example:
• Applying 100 Kg of Urea to 1
ha of maize may increase yield
by 15 bags, 10 bags or 5 bags
depending on other factors such
as the amount of rainfall, the
rate of weeding etc.
60
Risk Vs Uncertainty ...

61. • When the probability of an
outcome is known, we are
dealing with risk
• When the probability is not
known we have an uncertain
situation
61
Risk Vs Uncertainty ...

62. …refers to the set of unique outcomes for a
given event which can be assigned
probabilities
It exists when the decision-maker is in a position
to assign probabilities to various outcomes (i.e. a
probability distribution is known to him/her)
This happens when the decision-maker assigns
probability to other projects of the same nature
62
Risk ...

63. … refers to the outcomes of given event
which are too unsure to be assigned
probabilities
It exists when the decision-maker has no
historical data from which to develop a
probability distribution and must make
intelligent guesses in order to develop a
subjective probability distribution
63
Uncertainty ...

64. Positive Economics
Vs
Normative Economics
64

65. 65
• Deals with describing the
functioning of economic units
• Attempts to answer the question of
what is in term of:
- characteristics and nature of
relationships for households, firms,
markets and economic systems
Positive economics

66. 66
…. is purely descriptive statements or
scientific predictions:
“If A, then B,” a statement of what is ..
… statements of facts & logical
deductions
Positive economics …

67. The specification of goals or
policies is left to decision-makers
No prescription of what is good
or bad
Disagreements may be resolved
by gathering more facts
67
With positive economics ...

68. 68
Analysis involves value judgments
• Relates to whether things are good or bad
It is prescriptive
The analyst says what ought to be -
a statement of what ought to be …
Cannot be proved or disproved by
facts alone
Normative economics

69. Economic policy analysis falls under
normative economics
As policy advisors, economists make
normative statements - which attempt to
prescribe how the world should be
As scientists, economists also make positive
statements - which attempt to describe the
world as it is 69
Normative economics …

70. 70
oPositive economics deals with what is, whereas
normative economics deals with what ought to
be
oPositive statements are of the “if…then”
variety, while normative statements ask what
“should, or could” be
oPositive statements can be confirmed or refuted,
normative statements cannot
Differences: Positive Vs
Normative economics

71. 71
• Positive economics - serves as a basis
for making decisions in normative
economics
• Example:
Positive economics may be able to show that
a 5% tax increase on the rich will raise 10
billion TZS without significantly reducing
their consumption demand
How is positive economics related
to normative economics?

72. Normative economics may ....
.... go further to recommend that this
money will be best utilised if it is
allocated to public education and
public health - because this will
mostly benefit the poor who cannot
afford to go to private schools and
hospitals
72

73. Agricultural Economics
73

74. 74
Agricultural Economics
Is an applied science dealing with HOW
people choose to use technical knowledge and
scarce productive resources (land, labour and
management) to produce food and fibre and
distribute them for consumption to various
members of the society over time
It uses scientific methods to find answers to
problems in agriculture & agribusiness

75. 75
Agricultural Production Economics
• Is concerned primarily with
economic theory
• It relates to the producer of
agricultural commodities

76. Some major concerns include ...
• ... the role of economic theory in
production:
Goals and objectives of a farm manager
Choice of what output to produce
Allocation of resources among outputs
Risk and uncertainty
76

77. 77
Often assumed to be profit maximization!
Most economic models which are used to
represent the behaviour of farm managers
assume that – farm managers strive to
maximise profits
Or at least, strive to maximise revenue, subject
to some resource constraints
• But, individual farmers may have their own
unique goals
a) Goals & objectives of a farm manager

78. 78
A farm manager faces an array of
options with regard to what to
produce, given available labour &
farm tools
S/he must decide how much of each
particular commodity to produce
b) Choice of what output to produce ...

79. 79
Once the decision on what to produce has
been made, s/he must decide HOW the
available resources are to be allocated
among various outputs
Examples
Which crops should be planted on which farm/
plots?
How much of labour and machinery should be
allocated to each farm plot?
c) Allocation of resources among outputs ...

80. 80
Models of production economics
frequently assume that the manager knows
with certainty the applicable production
function
Examples
The yield that would result for a crop if a
particular amount of fertiliser was applied
The prices of both inputs to be purchased
and outputs to be sold
d) Risk and uncertainty ...

81. 81
But…
 ... in agriculture, the assumption of
perfect knowledge with respect to
the production function is never met
... the weather, an important factor
in agricultural production cannot
be predicted with certainty

82. 82
Animals and plants may develop
unexpected diseases and die

Crops may be affected by pests
and diseases
Prices of outputs cannot be known
with certainty at the beginning of
the production season

83. 83
... farmers must make decisions
with less than perfect
knowledge with regard to the
amount they will obtain at the
time of harvest (Y) and the
price at which they will sell
their produce (Py)
Thus…

84. 84
1.5
Assumptions
of
Pure/Perfect competition

85. 85
• Agriculture is often
considered the closest
approximation of the
perfectly competitive
model
Note that…

86. The basic assumptions of the model ...
a) A large number of buyers and sellers
exist in the industry
b) Farmers are price takers and not
price setters
c) The products are homogenous
d) There is free entry and exit
e) Perfect certainty
86

87. 87
a) A large number of buyers and sellers
exist in the industry
“Buyer and sellers are price takers in
the output and input markets
respectively” …
Although this assumption is valid to
a large extent, it does not always hold
true

88. 88
Examples
i. Fertiliser in Tanzania is
distributed by only a few
dealers
ii. Most traditional export crops
such as cotton, coffee,
tobacco and cashew nuts are
bought by a limited number
of buyers

89. iii. In some cases (e.g. tobacco,)
there has been evidence of
collusion among buyers to set
producer prices, thereby
violating the underlying
assumption that no single
buyer or seller is large
enough to influence the price
89

90. 90
b) Farmers are price takers
and not price setters
“Farmers can sell as much as they
want at the market price without their
supply to the market affecting the
market price” …

91. “The level of production by individual
farmers is so small that their
additional supply to the market does
not influence the price”
But - this assumption may be
violated in the case of monopolistic
producers/sellers of certain products
such as fertiliser, agricultural
chemicals or farm implements
91

92. 92
c) The products are homogenous
“The products produced by all firms
in the industry are identical”
“No need for advertising since there
is nothing to distinguish the product
of one firm from another” …

93. The assumption holds true for many
agricultural products

For instance, consumer is unlikely to
distinguish between maize from two
different farmers
93
The products are homogenous …

94. But, some producers may attempt to
differentiate their products in order to
fetch premium prices
For example, at Morogoro market, peas
from Matombo sell at a higher price than
similar looking peas from Iringa
94
The products are homogenous …

95. 95
• Implies “mobility of resources in and out
of farming”
• The free mobility assumption may be
easily met under smallholder peasant
agriculture
• But it becomes increasingly difficult to
transfer resources out of agriculture as
the level of specialisation and
capitalisation increases
d) There is free entry and exit

96. Difficult to transfer resources out ...
A farmer who just acquired a tractor
for maize production may find it
difficult to dispose it off within a
short time if market conditions
change such that maize production is
no longer profitable
96

97. 97
Other artificial restraints
to free entry may also exist
(e.g. the government policy)
•The pan territorial price
policy for inputs and outputs
that existed in Tanzania in
1970 & 1980s

98. oThe policy subsidised
agricultural production in
remote areas thereby interfering
with free entry
oIt allowed farmers who were not
competitive from an economic
efficiency point of view to enter the
maize production market
98

99. 99
• “All variables of concern to the
producer are known with
certainty”
• Some economists distinguish
between pure and perfect
competition
e) Perfect certainty

100. Some economists...
• ...argue that pure competition can exist even if
all variables are not known with certainty to
the producer and consumer
• Perfect competition will exist only if the
producer knows not only the prices for which
output will be sold but also the prices for
inputs
100

101. 101
With perfect competition, the
consumer has complete knowledge
with respect to prices
The producer is assumed to have
complete knowledge of the production
process or the function that transform
inputs or resources into output or
commodities

102. Assumption of complete knowledge ...
Since nature varies from year to
year, this assumption is violated
continuously in agriculture
102

103. 103
The assumption of pure or perfect
competition is often assumed in
economic analysis involving the
agricultural industry because:
 Despite its weakness, the perfectly
competitive model of economic behaviour
comes closer to representing farming than
other available models such as monopoly,
monopolistic competition or oligopoly
(models of imperfect competition)

104. ... in using the purely
competitive model during
analysis, modifications are made
depending on the specific
conditions of the particular
market or situation being
analysed
104