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General Agriculture

7 Economic Principles Associated with Agricultural Processing

Farm management principles associated with agricultural processing comprise a set of rules and economic theories, which ensure that choice of decision made will result in profit maximization motive of the farm manager.

Consequently, these principles of manager with the set of principles, theories and rules for decision making which are useful when making plans to organize and operate a farm.

They also helps in identifying which data are relevant for solving specific problems. They provide guidelines for processing data into useful information and for analyzing the potential alternatives.

In our study of agribusiness or farm management, we shall examine the following economic principles.

Seven (7) Economic Principles Associated with Agricultural Processing

7 Economic Principles Associated with Agricultural Processing

1. The Cost Principle

The cost principle examines the action of cost and income in the production process for a given farm enterprise. That is, the cost of input simple referred to as the factor price in relation to the price of output accruing from the production process (ie release or income).

Farm cost could be classified into fixed and variable cost. Fixed cost here represents the farm expenses that do not change with the changes observed in the level of outputs.

They are cost which could be paid for even when no production takes place. In a farm firm, some notably examples of fixed cost include, farm buildings, land payment made for interest in loans and principal, machinery, depreciation on capital assets, breeding stocks, payment made to permanent staff and family labour and permanent farm improvement (e.g. fencing).

The variable cost on the other hand are cost incurred by the agribusiness manager as his level of output changes. These cost do not occur if there is no production.

Examples of variable cost include expenses on such farm inputs as fertilizer, fuel for machine, livestock feeds, vertinary costs, seeds, casual labour. The concepts of fixed and variable costs are very important in making farm management decisions.

As long as the farm manager can cover his variable cost, he can afford to remain in business at least in the short run but in the long run he will be expected to cover both the fixed and variable cost as all cost are variable.

The cost principle carefully examines the relationship that exist between the fixed and variable cost with that of the total returns here, the total returns is expected to be greater than the total cost (fixed and variable cost).

For instance, if the returns are more than that of the variable and fixed cost, it is also expected that the production has gone in line with the law of the cost principle.

A cost function shows the various costs that will be incurred at various output levels, i.e., Cost =f (output)

Further, the rate of output is, in turn, a function of the usage of the resource inputs: Output =f (inputs).

Since the production function displays the relationships between input and output flows, once the prices of the inputs are known, the costs of a specific quantity of output can be determined.

As a result, the level and behavior of costs as a firm`s rate of output changes relies heavily on two factors:

(1) The characteristic of the underlying production function and

(2) The prices paid for the inputs. The first determines the shape of the firm`s cost functions, while the second decides the level of costs.

In the short run, at least one input is fixed, so that a firm may not be able to achieve the best combination of inputs for its desired level of output. Because of the presence of both fixed and variable costs in the short run, we can identify seven different types of short-run cost curves: total fixed cost, total variable cost, total cost, average fixed cost, average variable costs, average total cost, and marginal cost.

Note: In the long run, no resource costs are fixed. A firm can therefore vary the amount of any of its inputs. In the short run, one or more inputs are fixed.

2. The Set of Total Cost Concepts

Three concepts of total cost are important for analysis of a firm`s cost structure in the short run: total fixed cost (TFC), total variable cost (TVC), and total cost (TC).

Total fixed cost (TFC) is simply the sum of the quantities of the fixed inputs multiplied by their associated prices. In the short run the level of total fixed costs is a constant.

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Similarly, total variable cost (TVC) is the sum of the amounts a firm spends for each of the variable inputs employed in the production process.

Total variable cost is zero when output is zero, because no variable inputs need be employed to produce nothing. However, as output expands, the greater becomes the usage of variable inputs and the greater is total variable cost.

The total cost (TC) of a given level of output in the short run is the sum of total variable cost and total fixed cost:

TC = TVC + TFC

TVC are costs that vary in total in direct proportion to changes in activity. Examples are direct materials and gasoline expense based on mileage driven. TFCs are costs that remain constant in total regardless of changes in activity. Examples are rent, insurance, and taxes.

3. The Set of Unit Cost Concepts

There are four major unit cost concepts: average fixed cost (AFC), average variable cost (AVC), average total cost (ATC), and marginal cost (MC). All of these may be derived from the total cost concepts discussed above.

Average variable cost (AVC) is total variable cost divided by the corresponding number of units of output, or

AVC = TVC/Q

Average fixed cost (AFC) is defined as total fixed cost divided by the units of output, or AFC = TFC/Q

Since total fixed cost is a constant amount, average fixed cost declines continuously as the rate of production increases. The reduction of AFC by producing more units of output is what business people commonly call spreading the overhead.

Average total cost (ATC) is defined as total cost divided by the corresponding units of output, or ATC = TC/Q

However, since TC = TFC + TVC, ATC = TC/Q = (TVC + TFC)/Q = TVC/Q + TFC/Q = AVC + AFC Graphically, ATC is U-shaped because the AVC is an increasing function, while the AFC is a continuously decreasing function of output.

Marginal Cost

Marginal cost (MC) is the cost of producing an additional unit of output. For example, the marginal cost of the 500th unit of output can be calculated by finding the difference in total cost at 499 units of output and total cost at 500 units of output.

MC is thus the additional cost of one more unit of output. MC is also the change in total variable cost associated with a unit change in output. This is because total cost changes, whereas total fixed cost remains unchanged.

MC may also be thought of as the rate of change in total cost as the quantity (Q) of output changes and is simply the first derivative of the total cost (TC) function. Thus,

MC = .TC/.Q = dTC/dQ

Economists normally assume firms to be producing at a point at which marginal costs are positive and rising. In managerial applications of this concept, MC is viewed as being equivalent to incremental cost which is the increment in cost between the two alternatives or two discrete volumes of output.

Note: AFC is inversely related to the average product (AP) of the fixed inputs. AVC is inversely related to the average product (AP) of the variable inputs.

MC is inversely related to the marginal product (MP) of added units of variable inputs. If L is variable input and w = its wage, then AVC = w/APL; MC = w/MPL

4. Principles of Diminishing Returns

The principles of diminishing returns have a special application in the science of farm management. That is, when we consider the level of output or yield from a fixed area of land such as one lecture or product form a single livestock or crop.

The law of diminishing returns which was originally propounded by David Ricardo (1771-1823), in relation to the ability of an agrarian economy with a growing population, fixed agricultural land and variable inputs to expand her output of food, states that if you continue to add more of variable inputs to a fixed factor (e.g. land), the total product will first of all increase at an increasing rate, then at a decreasing rate and thereafter starts to decline as it reaches its maximum.

This principle guides the efficient allocation of resources in that as more resources are added, more yields are expected to a certain level in the production process.

Again if resources are constantly added, it reaches a point where the output decreased. This action or decreasing stage makes us to realize the proper ways of utilizing limited resources.

5. Opportunity Cost Principle

Opportunity cost principle which is known as marginal return principle or real cost principle is applied in economics to express “Cost” in terms of forgone or sacrificial alternative.

The principle underlines the basic economic problems of scarcity and choice and is relevant to the behavior of the agribusiness manager, the individual consumers and the government.

The agribusiness manager is faced with the scarcity of resources and therefore is involved also in making choice so the concept guides the manager in deciding how best to use the available productive resources in his farm production business.

To him, the principle of opportunity cost states that profit will be greater if each unit of labuor capital and land is used where it will add the most value to the returns. It does not say that resources should always be used where they will bring in the greater marginal returns.

This therefore means that the clever the choice of enterprise goes towards profitability with added returns when capital and other resources are limited.

The individual consumers are also faced with the problem of choice from the available scarce resources to satisfy their needs.

The concept helps them to decide how to spend their scarce money resource in buying one bundle of commodities while forgoing the other bundles which is now regarded as his real cost.

The concept of opportunity cost is also relevant to the government: this is because government is faced with the problem of limited budget at her disposal to carry out all the proposed agricultural projects and programmes.

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The principle therefore helps the government in deciding how best to use her revenue. If government emphasis and effort are directed towards food crop production rather than livestock and rural infrastructural development, then the real cost of facilitating food crop production are the livestock production and improvement in rural infrastructures, which are not provide.

6. Principles of Substitution in Choice of Practices

In this principle of substitution in choice of practice, we consider the better competing variance in our agribusiness practices. Hence, we consider two types of resources which can be used in producing a given output.

In consideration of this, we decide which is more profitable and which has equally a minimal cost of production.

For instance, weeding with hand tools and applying herbicides or buying tractor for land preparation and hiring if for the same purpose.

This farm manager who is always aiming at making the highest possible profit must try as much possible to minimize production cost. To achieve this, he should be able to adopt a better competing variance or practice that affect this least cost while making appropriate returns on investment.

7. Principles of Farm Valuation and Depreciation

These are important concepts in farm or agribusiness management. Valuation by word means the process of deciding the value of something. It is also a way of rating or estimating the worth of a property or an asset.

Farm valuation therefore means a process of attaching prices of given assets such as building, machines, vehicles, working tools, crops and livestock, stored products and other valuable properties within a given farm firm.

To set the true estimate of farm profit, changes in the value of the farm assets and liabilities should be included. The farm should therefore be valued at the beginning and end of the accounting period (usually within one year).

The valuation at the beginning is known as opening valuation and one at the end is known as closing valuation for one period is therefore the same as the opening valuation for the next period.

The method of valuation affects the profit or loss on a given farm and therefore the need to follow the same method of valuation each year. Some of the common methods mostly used in assessing the worth of farm assists are listed below:

  • Valuation at market price  
  • Valuation at cost
  • Valuation by reproductive value
  • Valuation at next selling price
  • Valuation at cost less depreciation.

Read Also : List of Problems Confronting Livestock Production

Do you have any question, suggestion or other contributions? kindly use the comment box provided below for all your contributions. You are also encouraged to please kindly share this article with others you feel can benefit from this information if found useful enough as we may not be able to reach everyone at the same time. Thank you so much for sharing!

Agric4Profits

Benadine Nonye is an agricultural consultant and a writer with several years of professional experience in the agriculture industry. - National Diploma in Agricultural Technology - Bachelor's Degree in Agricultural Science - Master's Degree in Science Education - PhD Student in Agricultural Economics and Environmental Policy... Visit My Websites On: 1. Agric4Profits.com - Your Comprehensive Practical Agricultural Knowledge and Farmer’s Guide Website! 2. WealthinWastes.com - For Effective Environmental Management through Proper Waste Management and Recycling Practices! Join Me On: Twitter: @benadinenonye - Instagram: benadinenonye - LinkedIn: benadinenonye - YouTube: Agric4Profits TV and WealthInWastes TV - Pinterest: BenadineNonye4u - Facebook: BenadineNonye

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