AgriculturalProduction Economics

The Author

Dr. K. Nirmal Ravi Kumar is presently working as Professor andHead (Agricultural Economics) in Agricultural College, Mahanandi inAcharya N.G. Ranga Agricultural University. He had a brilliant academiccareer and he specialized in ‘Agricultural Marketing’ both in his post-graduate and doctoral programmes. He is actively involved both inagricultural research and teaching activities during the past thirteen yearsin the University. He published 44 articles in popular agricultural journals.

He also contributed two technical bulletins on economic aspects of irrigation watermanagement highlighting the research priorities in major irrigation commands of AndhraPradesh and need based technological interventions to address the same during his activestint in “Andhra Pradesh Water Management Project”, an international project funded byThe Royal Netherlands Embassy. His interested areas include International trade of Indianagriculture, Farming systems approach, Irrigation water management etc. The followingare the other major contributions (books) by the same author:

Indian Agriculture in the 21st Century: Challenges and OpportunitiesWorld Trade Agreement and Indian Agriculture: Implementation ExperienceMicroeconomic Analysis in Agriculture in 2 Vols (Set)Objective Agricultural Economics (Two Editions)Farmers Indebtedness in India – An Economic AnalysisResearch Methodology for Agricultural EconomicsMethodology for Social Sciences Research in AgricultureAgricultural Marketing in 2 Vols (Set)Farm Managerial EconomicsPractical Knowledge in Agricultural Economics

AgriculturalProduction Economics

Volume 1

K. Nirmal Ravi KumarProfessor and Head (Agricultural Economics)Acharya N.G. Ranga Agricultural University

Agricultural College,Mahanandi

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Agricultural Production Economics(2 Volume Set)

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Ravi Kumar, K. N. (Kotamraju Nirmal), 1969- author.Agricultural production economics / K. Nirmal Ravi Kumar.2 volumes cmIncludes bibliographical references (pages ).

ISBN 978-93-5124-669-5 (Vol.1)ISBN 978-93-5124-338-0 (Set)

1. Agriculture—Economic aspects—India. 2. Agriculturalproductivity—India. 3. Factors of production—India. I. Title.

DDC 338.10954 23

Publisher’s note:Every possible effort has been made to ensure that the information contained in this book is accurate at the timeof going to press, and the publisher and author cannot accept responsibility for any errors or omissions,however caused. No responsibility for loss or damage occasioned to any person acting, or refraining fromaction, as a result of the material in this publication can be accepted by the editor, the publisher or the author.The Publisher is not associated with any product or vendor mentioned in the book. The contents of this workare intended to further general scientific research, understanding and discussion only. Readers should consultwith a specialist where appropriate.Every effort has been made to trace the owners of copyright material used in this book, if any. The author andthe publisher will be grateful for any omission brought to their notice for acknowledgement in the futureeditions of the book.All Rights reserved under International Copyright Conventions. No part of this publication may be reproduced,stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying,recording or otherwise without the prior written consent of the publisher and the copyright owner.

© 2015 AUTHOR

– Dedicated to –Late K. RAMA CHANDRA RAO

Foreword

Agricultural sector plays an important role in the economy of every country. In adeveloping country like India, it provides employment to about one half of the laborforce in the country and supplies raw material to many industries, although its sharein the Gross Domestic Product has been steadily declining to reach only about 13 percent in the recent years. The relatively low labor productivity of agriculture all overthe world has been a sign of structural retrogression and is perplexing to the policymakers. While there are many explanations to this phenomenon, none consider it adesirable state of affairs. Till the twentieth century, there were many famines in Indiadue to which many people lost their lives due to shortage of food. In the presentcentury, famines are avoided due to increased production and better food distributionsystem, but many farmers are taking their lives by suicides due to financial hardshipand business failure. Agriculture is failing to attract youth due to its low remunerativenature and many policy makers and analysts are concerned about its future and thefood security of the countries.

In this context, a book that unravels the intricacies of agricultural production atthe farm firm level is welcome. There were many books on the subject over the lastcentury which blazed the path of knowledge and filled the curiosity of the students

K. PURNA CHANDRA RAOFormerly Principal Scientist

(Village Level Studies)ICRISAT

Phone : 9848081608E-mail: kpcr_48@rediffmail.com

and researchers. One more book on the subject is welcome. The author made no claimof originality but tried to explain the concepts in popular style so that the beginnerscan easily grasp them. I congratulate Dr. K. Nirmal Ravi Kumar for his initiative,enterprise and hard work to bring out this book so early in his career. I hope that theprofessionals and students find it useful.

K. Purna Chandra Rao

viii

ACHARYA N.G. RANGA AGRICULTURAL UNIVERSITY

AGRICULTURAL COLLEGE, MAHANANDI

M.C. FARM – 518 502, MAHANANDI, KURNOOL DISTRICT

Author’s Note

I consider this as a bold attempt to present a comprehensive text material on thefundamental aspects of Agricultural Production Economics. With a limited experiencein the field of teaching (7 years) in the Acharya N.G. Ranga Agricultural University,I will not dare enough to make a tall claim regarding the originality of the materialincorporated in this text book entitled, ‘Agricultural Production Economics’, but Icertainly admit that, the concepts are dealt in-detail in a lucid form, so as to enable thestudents and Academicians to learn, understand and conceptualize the same. Thepresent volume can serve as a standardized text book for the graduates, post-graduatesand doctoral students, who wish to pursue their career in the field of AgriculturalEconomics in different State Agricultural Universities.

This task of writing and publishing the textbook on the advanced versions of‘Agricultural Production Economics’ has been one of the most challenging and satisfyingexperiences of my life. I am especially thankful to my student Ms. V. Usha Shree forthe help rendered during the pursuit of this work. Finally, last but by no means least,a grateful kiss goes to my wife, Meena, my sons, Sri Ram and Kasyap, my brotherVijay and cheerful thanks to my mother Janaki for their love and support. Theirdevotion, patience and understanding were indispensable. I gratefully dedicate this

Dr. K. NIRMAL RAVI KUMAR Ph.D

Professor & HeadDept. of Agricultural Economics

Phone : +91-9295350511Email: drknrk@gmail.com

piece of work to my late father, K. Rama Chandra Rao, who instilled in me at an earlyage the importance of education and the value of hard work. I only wish you couldhave been here to see me finish the journey I started with your efforts and initiatives.I know you would have been so proud.

K. Nirmal Ravi Kumar

x

Contents

Foreword vii

Author's Note ix

Acronyms xvii

Volume 1

1. Basic Concepts in Agricultural Production Economics 1

Factors of Production – Goals and Objectives of Agricultural ProductionEconomics – Subject Matter of Agricultural Production Economics – BasicProduction Problems in Agriculture – Causes of basic production problems –Tools of Agricultural Production Economics – Consumption theory vis-à-visTheory of Agricultural Production Economics – Features of Modern AgriculturalProduction – Agricultural Production vis-à-vis Industrial Production – Basicterms and concepts in Agricultural Production Economics

2. Factor – Product Relationship:

One Product, One Variable Factor 57

Production function – Concept of period in production function – Short runproduction function – Long run production function – Assumptions in productionfunction analysis – Change along the production function and Change inproduction function – Agro-technology and Production function – Types ofTechnological Change in Agriculture – Influence of Technology on ProductionFunction – Technological progress and position of isoquants – Measuring incomeinequality among farmers due to adoption of production technology – Effects inthe use of modern technology – Aggregate Production Functions – Forms ofAgricultural Production Function – Uses or Importance of AgriculturalProduction Function – Types of production functions – Linear homogenousproduction function – Non-homogenous production function of ‘r’ degree –Algebraic Forms of the Production Function – Linear production function –Quadratic Production Function – Cubic (Neo-classical) Production Function –Cobb-Douglas Production Function – Square root production function –Transcendental production function – Leontief production function – CESproduction function – Translog Production Function – Homogeneous productionfunction – Homothetic production function – Basic concepts in short run (cubic)production function – Production function with one variable factor (Returns to avariable factor) – Traditional approach – Increasing (marginal) returns to avariable factor or Law of increasing (marginal) returns – Constant (marginal)returns to a variable factor or Law of constant (marginal) returns – Diminishing(marginal) returns to a variable factor or LDR – Modern Approach-LVP (Neo-Classical Production Function) – Assumptions – Explanation of the law – Shapesof TPP, MPP and APP curves – Relationship between TPP, MPP and APP –Reasons for increasing MRs – Reasons for constant MRs – Reasons fordiminishing MRs – Reasons for negative MRs – Sign, Slope and Curvature ofMPP and APP curves – Differences between three stages of LVP – Limitations ofLDR – Importance of LDR – Differences between Traditional approach andModern approach of Returns to a variable factor – Long run production function– Returns to scale – Increasing RTS – Constant RTS – Diminishing RTS – MRsto a variable factor and RTS – MRs to a variable factor and Increasing RTS –MRs to a variable factor and Constant RTS – MRs to a variable factor andDiminishing RTS – Differences between LVP and Returns to scale – Explanationof LVP in terms of isoquant approach – Examples – Exercises

3. Factor – Factor Relationship -

One Product, Two Variable Factors 203

Isoquant – Properties of isoquants – Similarities between isoquant and IDC ofconsumption theory – Dissimilarities between isoquant and IDC of consumptiontheory – Iso-cost line – Slope of the iso-cost line – Position and Shifts in iso-costline – Optimum factor combination – Marginal Product Approach – Isoquant –Isocost Approach – Types of resources and their relationships – Three Stages ofProduction Function under Factor-Factor Relationship – Isocline – Expansion

xii

path – Ridgeline – Deriving production function from isoquant map and ridgelines – Effect of changes in factor price on factor usage – Substitution relationshipbetween the factors – Complementarity relationship between the factors – Factorsare perfect substitutes – Factors are perfect complements – Difference betweenexpansion path and price-factor curve – Elasticity of factor substitution –Examples – Exercises.

4. Product – Product Relationship 293

Production Possibility Curve – Assumptions – Construction of a PPC – Propertiesof Production possibility curve – PPC vis-a-vis Isoquant – Iso-revenue line –Optimum Products Combination – Opportunity cost approach – PPC and Iso-revenue line approach – Types of enterprise combinations – Isocline – Ridgeline– General Equilibrium – Examples – Exercises.

5. Theory of Costs: Costs and their Behaviour Patterns 343

Different types of costs – Explicit costs – Implicit costs – Accounting costs –Economic costs – Money cost – Real costs – Opportunity cost – Limitations ofopportunity cost – Private costs – Social cost – Incremental costs- Sunk costs –Out-of-pocket Costs – Book Costs – Original costs – Replacement costs –Controllable costs – Non-controllable costs – Shutdown costs – Abandonmentcosts – Urgent costs – Postponable costs – Short-run costs – Long-run costs –Cost analysis in the short run and long run production programmes – Recoveryof costs – Equilibrium conditions of the firm – Incremental cost – Marginal cost– Theories of costs – Traditional theory of costs – Short run costs – Short runAbsolute costs – TFC – SRTVC – SRTC – Short run per unit costs – AFC –SRAVC – SRATC – SRMC – Derivation of short run per unit cost curves fromshort run absolute cost curves – Effects of taxes on cost structure of a firm – Effectof specific tax – Imposition of license fees – Traditional theory – Long run costs– Long run Absolute cost – LRTC – Influence of rise in price of one of the inputson LRTC – Long run per unit costs – LRATC – LRMC – Derivation of LRATC– Differences between SRATC and LRATC – Shapes of LRATC curve – LRMC– Derivation of LRMC – Shape of LRMC curve – Optimum size firm – Factorsinfluencing optimum plant size – Relation between LRATC and SRATC curves– Relation between LRMC and SRMC curves – Modern theory of costs – Shortrun per unit cost curves – AFC – SRAVC – SRATC – SRMC – Long run per unitcost curves – Experience curve or Learning by doing – Derivation of LRTC,LRATC and LRMC curves – Derivation of LRTC curve from expansion path –Derivation of LRATC curve from LRTC curve – Derivation of LRMC curvefrom LRTC curve – Cost function – Functional Forms of Cost Function – Linearcost function – Quadratic cost function – Cubic cost function – Deriving CostFunctions from Production Functions – Properties of Cost Functions – Relationbetween cost function and production function – TPP and SRTC – APP andSRATC – MPP and SRMC – Cost function vis-à-vis Production function –Production decisions when price of output changes – Cost function from factorsside – Assumptions – Basic concepts of productivity – APP – MPP – ARP –

xiii

MRP – VMP – AFC – MFCx – Factor pricing under perfect competition –Remuneration paid to the factor is equal to its marginal productivity – Firm’sequilibrium in the short run – Long run industry equilibrium – Payment for thefactor across different firms – Factor pricing under imperfect competition –Examples – Exercises.

Volume 2

6. Economies and Diseconomies of Scale 465

Economies of scale – Importance of economies of large scale – Types of economiesof large scale – Internal economies of large scale – External economies of largescale – Diseconomies of large scale – Internal diseconomies of large scale –External diseconomies of large scale – Avoiding diseconomies of large scale –Measurement of economies of scale – Economies of scope – Sources of economiesof scope – Examples – Exercises.

7. Concepts of Revenue and Firm’s Equilibrium 487

Different concepts of revenue – ARC and MRC under perfect market competition– ARC and MRC under imperfect market competition – Monopoly – Oligopoly– Monopolistic competition – Derivation of ARC and MRC from TRC – Relationbetween TR, AR and MR curves – Relationship between TR, AR, MR and priceelasticity of demand – Determination of firm’s equilibrium – Normal profits –Super–normal profits – Sub-normal profits – Assumptions to determine firm’sequilibrium – Methods to determine the firm’s equilibrium – TR and TC approach– Firm’s equilibrium based on TR and TC approach under perfect competition –Firm’s equilibrium based on TR and TC approach under imperfect competition– Case of profit maximization – Case of minimization of losses – Limitations ofTR and TC approach – MR and MC approach – Firm’s equilibrium based onMR and MC approach under perfect competition – Firm’s equilibrium based onMR and MC approach under imperfect competition – MR=MC analysis inmarkets with linear demand – Break Even Point – Margin of safety – Importanceof analyzing BEP – Limitations of BEP analysis – Examples – Exercises.

8. Profit Analysis 539

Distinguishing features of profits – Different types of profits – Economic profit– Accounting profit – Gross profit – Net profit – Modern theory of profits orDetermination of profits under perfect competition – Profit maximizing criteria– Maximization of profits at the point of equality of MC=MR – Concept ofequality of MR=MC in perfect competition – Equilibrium of firm and industryunder perfect competition in the short run – Equilibrium of the firm and industryin the short run under identical cost conditions – Equilibrium of the firm in theshort run under varying cost conditions – Equilibrium of firm and industryunder perfect competition in the long run – Equilibrium of the firm in the longrun – Equilibrium of the industry in the long run – Long run equilibrium of thefirms and industry under identical cost conditions – Long run equilibrium of the

xiv

firms under varying cost conditions – Concept of equality of MR=MC in imperfect(monopoly) competition – Equilibrium of monopoly firm or industry in theshort run – Equilibrium of monopoly firm or industry in the long run – Profitsfunction – Properties of the Profit Function – Exercises.

9. Linear Programming 589

Basic terminology used in LP technique – Linear Programming Structure orComponents of LP Problem in Standard form – Assumptions in LP technique –Production Processes in LP – Formulation of LP model – Graphical method –Profit maximization objective functions – Corner point approach – Iso-profitline approach – Dual of the problem – Primal vs Dual problems – Costminimization objective function – Corner point approach – Iso-cost line approach– General procedure of Graphical approach – Sensitivity Analysis – Specialcases in graphical method – Alternate (or Multiple) Optimal Solutions –Unbounded Solution – Infeasible Solution – Simplex Method – Profitmaximization objective function – Marginal Value Productivity – Shadow prices– Generalized procedure of Simplex method (Maximization function) – Costminimization objective function – Complications in Simplex Method –Limitations of Simplex method – LP Problems involving slack, surplus andartificial variables – Degeneracy – Transportation Problem – Requirements oftransportation model – Assumptions of transportation model – Formulation oftransportation model – Characteristics of Transportation Model – Balanced andUnbalanced transportation models – Things to remember for solvingTransportation problem – Initial Feasible Solutions in transportation problems– The North-West Corner Rule – Assignment by Inspection or Judgement orLCM or Minimum Cell Cost Method – Vogel’s Approximation Method – Criteriato identify initial or basic feasible solution – Test for optimality – Stepping-Stone Method – MODI Method – Generalized procedure to solve a transportationproblem – Merits of LP technique – Limitations of LP technique – Concept ofoptimality – Decision making by consumer – Consumer’s equilibrium when thecommodity is available free of cost to the consumer – Consumer’s equilibriumwhen commodity is priced to the consumer – One-commodity consumer’sequilibrium – Two commodities or More than one commodity consumer’sequilibrium – Decision making by producer – Optimization of output throughincreasing resource use efficiency – Cost minimization in a production programme– Cost minimization for a given level of output – Output maximization for agiven cash outlay and prices of the resources – Profit maximization for a givenlevel of resources – Decision making by the firm – LP technique – Exercises.

10. Economic Analysis of Agricultural Projects 711

Project vs Programme – Project Cycle – Project Appraisal Techniques –Undiscounting technique – Ranking by inspection – Payback Period – Proceedsper Rupee Outlay – Average Annual Proceeds per Rupee Outlay – DiscountingTechnique – Discount rate – Opportunity Cost of Capital – Social Discount Rate– Net Present Worth – Benefit Cost Ratio – IRR – MIRR – N/K ratio, Profitability

xv

Index – Differences between Discounting and Undiscounting techniques –Sensitivity Analysis – Switching Value Percentage Method – Shadow Price –Differences between Financial Analysis and Economic Analysis of Project –Project Scheduling or Project Management Techniques – Bar charts – Ganttchart – Milestone Chart – Net Works – Differences between CPM and PERT –Net Work Analysis -.Terminology used in CPM and PERT – NetworkConstruction or Drawing a Network Diagram – Steps involved in NetworkAnalysis – Components of network analysis – Project Crashing – Time-CostTrade Off – Procedure for project crashing – Exercises.

References 805

xvi

Acronyms

AC: Average CostAFC: Average Fixed Cost

AE: Allocative EfficiencyAFCX: Average Factor CostAPP: Average Physical Product

AR: Average RevenueARC: Average Revenue CurveARP: Average Revenue ProductATC: Average Total CostAVP: Average Value ProductBCR: Benefit Cost RatioBEP: Break Even PointBFS: Basic Feasible SolutionCES: Constant Elasticity of Substitution

CMR: Contribution Margin RatioCPM: Critical Path MethodCVP: Cost-Volume-Profit

EE: Economic EfficiencyEFT: Earliest Finishing TimeEOC: Output elasticity of LRTC

EP: Elasticity of ProductionES: Elasticity of Substitution

EST: Earliest Start TimeFAO: Food and Agriculture Organization

GC: Gini CoefficientGM: Genetically ModifiedIDC: Indifference CurveIRR: Internal Rate of Return

LCC: Least Cost CombinationLCM: Least Cost MethodLDR: Law of Diminishing ReturnsLFT: Latest Finishing Time

LP: Linear ProgrammingLRAC: Long Run Average Cost

LRATC: Long Run Average Total CostLRMC: Long Run Marginal Cost

LRS: Long Run SupplyLRTC: Long Run Total Cost

LST: Latest Start TimeLVP: Law of Variable ProportionsMC: Marginal Cost

MES: Minimum Efficient SizeMFCX: Marginal Factor CostMIRR: Modified Internal Rate of ReturnMODI: Modified Distribution

MPP: Marginal Physical ProductMR: Marginal Returns or Marginal Revenue

MRC: Marginal Revenue CurveMRP: Marginal Revenue Product

MRPS: Marginal Rate of Product SubstitutionMRS: Marginal Rate of Substitution

xviii

MRTS: Marginal Rate of Technical SubstitutionMSPs: Minimum Support Prices

MU: Marginal UtilityMVPX: Marginal Value Product of a factor

NB: Net Incremental BenefitsNBIR: Net Benefit Investment RatioNPV: Net Present Value

NPW: Net Present WorthNWC: North West Corner RuleOCC: Opportunity Cost of CapitalOPC: Optimum Product CombinationPBP: Pay Back Period

PERT: Programme Evaluation and Review TechniquePI : Profitability Index

PPC: Production Possibility CurvePPF: Production Possibility Frontier

PWB: Present Worth of BenefitsPWC: Present Worth of Costs

PX: Price of the variable input ‘X’PY: Price of the output or product ‘Y’

R&D: Research and DevelopmentRTS: Returns to ScaleSDR: Social Discount Rate

SRATC: Short Run Average Total CostSRAVC: Short Run Average Variable Cost

SRMC: Short Run Marginal CostSRS: Short Run Supply

SS: Social SurplusSRD: Social Rate of Discount

SRTC: Short Run Total CostSRTVC: Short Run Total Variable Cost

TAI: Technology Adoption IndexTC: Total CostTE: Technical Efficiency

TFC: Total Fixed CostTFCX: Total Factor CostTPP: Total Physical Product

xix

TR: Total ReturnsTRC: Total Revenue Curve

TU: Total UtilityTVC: Total Variable CostTVP: Total Value Product

VAM: Vogel’s Approximation MethodVAP: Value of the Average ProductVMP: Value of Marginal ProductWTO: World Trade Organization

xx

1Basic Concepts in Agricultural

Production Economics

Growth in agricultural production is necessary not only to increase foodavailability and raise nutrition levels of the population, but also essential in thedevelopmental process of any country. Considering the food security needs of themounting global population, boosting agricultural production is essential. Further,the channeling of agricultural surplus (production in excess of consumption) to thenon-farm sector is important in the context of economic development of any country.This text book is not meant to analyze the way, how agricultural production booststhe economic development of a country, but to focus on the determinants of agriculturalproduction. Agricultural production is important because of the fact that, all economicactivities depend on it. For consumption to take place, goods and services must beproduced. Without production, goods and services will not be produced. We areaware of the fact that, farmers employ four factors of production viz., Land, Labour,Capital and Management in taking up the agricultural production process and inproducing the output. Thus, ‘Agricultural Production’ is the process of transformationby which resources and resource services are transformed into output (Figure 1.1).

Agricultural Production Economics2

Thus, commodities (output) that are demanded and supplied are produced bytransforming some other goods (called resources and resource services) into them.This process takes place in producing units called farms and factories. However, theuse of these terms like inputs and output is not permanent because, what is an output(product) to one person may be an input to another person. For example, a farmermay produce maize (output) using land, labour, capital and his managerial skills asfactors of production. On the other hand, a poultry farmer sees the maize as one of theinputs in producing eggs or chicken as output. Thus, the output of a firm can either bea final commodity or an intermediate product. Even the output can also be a servicerather than a good such as agricultural education, banking etc. In general, ‘Production’refers to the creation of wealth. Strictly speaking, in terms of satisfaction derived, itrefers to the creation of utilities. Utility refers to the want satisfying capacity of a good.A good or service may create utility to a person in five different ways viz., form utility(created by processing function), place utility (created by transportation function),time utility (created by storage function), possession utility (created by buying andselling function) and task utility (this utility is provided, when someone performs atask for someone else. For instance, when a bank handles financial transactions for afarmer to offer pledge loan for efficient marketing of produce, it falls under taskutility).

I. Factors of Production

For production of goods, rather creating utility, the farmer employs both resourcesand resource services and these efforts will produce the goods that satisfy human

Factors of Production

Land, Labour, Capital &

Management

ResourcesSeeds, Fertilizers,

Pesticides etc.

Resource ServicesHuman labour, Bullock labour,

Machinery labouretc.

Process of Productionin Farm or

Factory

OUTPUT/PRODUCT

Figure 1.1: Process of Agricultural Production.