TAMIL NADU AGRICULTURAL UNIVERSITY

DEPARTMENT OF AGRICULTURAL ECONOMICS

LECTURE NOTES
Course
AEC 201 Farm Management, Production a n d R e s o u r c e Economics (1+1)

Compiled by
Prof. Dr.K.R.Karunakaran, Ph.D
Department of Agricultural Economics, CARDS,
Tamil Nadu Agricultural University,
Coimbatore 641 003

2018
 AEC 201 Farm Management, Production and Resource Economics (1+1)
Semester III (2017 Syllabus)
Objectives
This course aims at imparting knowledge on principles of farm management, production
economics and natural resource economics in terms of their properties, externalities and
management. This course also would help the Under Graduate students in using different
methods and tools for decision making in farm management, which would facilitate profit
maximization through optimizing farm resource use.
Theory
Unit 1: Production Economics and Farm Management - Nature and Scope
Meaning and concept of farm management, objectives and relationship with other sciences.
Meaning and definition of farms, its types and characteristics, factors determining types and size
of farms. Types of farming: Specialized, Diversified, and Mixed farming – Systems of farming:
Peasant Farming, State Farming, Capitalistic, Collective and Co – operative Farming.
Unit 2: Factor – Product, Factor – Factor and Product – Product Relationships
Principles of farm management: concept of production function and its characteristics and its
type, use of production function in decision-making on a farm. Factor-Product relationship.
Meaning, Definition – Laws of Returns. Meaning and concept of cost, types of costs, cost curves -
and their inter-relationship - shut down and break-even points, importance of cost in managing
farm business and estimation of gross farm income, net farm income, family labor income and
farm business income. Economies of Scale – Economies of Size - Determination of Optimum
Input and Output – Physical and Economic Optimum. Factor – Factor relationship: Least Cost
Combination of inputs; Product – Product relationship: Optimum Combination of Products –
Principle of Equi – Marginal Returns – Principle of Opportunity Cost and Minimum Loss Principle.
Law of Comparative Advantage.
Unit 3: Farm Planning and Budgeting
Farm business analysis: meaning and concept of farm income and profitability, technical and
economic efficiency measures in crop and livestock enterprises. Importance of farm records and
accounts in managing a farm, various types of farm records needed to maintain on farm, farm
inventory, balance sheet, profit and loss accounts. Meaning and importance of farm planning and
budgeting, partial and complete budgeting, steps in farm planning and budgeting - linear
programming, appraisal of farm resources, selection of crops and livestock’s enterprises.
Unit 4: Risk and Uncertainty in Agriculture Production
Concept of risk and uncertainty occurrences in agriculture production, nature and sources of
risks and their management strategies, Crop / livestock / machinery insurance. Weather based
crop insurance - Features and determinants of compensations.
 Unit 5: Resource Economics
Resource Economics: Concepts, Classification, differences between Natural Resource
Economics (NRE) and agricultural economics, unique properties of natural resources. Natural
Resources - Issues – Scarcity of resources – Factors mitigating scarcity – Property Rights:
Common Property Resources (CPRs): meaning and characteristics of CPRs – Externalities:
meaning and types - positive and negative externalities in agriculture, Inefficiency and welfare
loss, solutions; Important issues in economics and management of common property resources of
land, water, pasture and forest resources.
Practical
Preparation of farm layout. Determination of cost of fencing of a farm. Computation of
depreciation cost of farm assets. Application of equi-marginal returns / opportunity cost principle in
allocation of farm resources. Determination of most profitable level of inputs use in a farm
production process. Determination of least cost combination of inputs. Selection of most profitable
enterprise combination. Application of cost principles including CACP concepts in the estimation of
cost of crops – Estimation of costs and returns of livestock products. Preparation of farm plan and
budget, farm records and accounts and profit and loss accounts. Break – even analysis- Graphical
solution to Linear Programming problem. Collection and analysis of data on various resources in
India.
Theory Schedule
1. Meaning and concept of farm management, objectives and relationship with other
sciences. Meaning and definition of farms, its types and characteristics, factors determining types
and size of farms.
2. Types of farming: Specialized, Diversified, and Mixed farming – Systems of farming:
Peasant Farming, State Farming, Capitalistic, Collective and Co – operative Farming.
3. Principles of farm management: concept of production function and its characteristics and
its type, use of production function in decision-making on a farm.
4. Factor - Product relationship: Meaning, Definition – Laws of Returns: Classical production
function and its characteristics.
5. Meaning and concept of cost, types of costs, cost curves - and their inter-relationship -shut
down and break-even points, importance of cost in managing farm business and estimation of
gross farm income, net farm income, family labor income and farm business income.
6. Economies of Scale – Economies of Size - Determination of Optimum Input and Output –
Physical and Economic Optimum.
7. Factor – Factor relationship: Least Cost Combination of inputs.
8. Product – Product relationship: Optimum Combination of Products – Principle of Equi –
Marginal Returns – Principle of Opportunity Cost and Minimum Loss Principle. Law of
Comparative Advantage.
9. Mid Semester Examination.
10. Farm business analysis: meaning and concept of farm income and profitability, technical
and economic efficiency measures in crop and livestock enterprises.
11. Importance of farm records and accounts in managing a farm, various types of farm
records needed to maintain on farm, farm inventory, balance sheet, profit and loss accounts.
12. Meaning and importance of farm planning and budgeting, partial and complete budgeting,
steps in farm planning and budgeting - linear programming, appraisal of farm resources, selection
of crops and livestock’s enterprises.
13. Concept of risk and uncertainty occurs in agriculture production, nature and sources of
risks and its management strategies.
14. Crop / livestock / machinery insurance. Weather based crop insurance - Features and
determinants of compensations.
15. Resource Economics: Concepts, Classification, differences between Natural Resource
Economics (NRE) and agricultural economics, unique properties of natural resources.
16. Natural Resources Issues – Scarcity of resources – Factors mitigating scarcity – Property
Rights – Common Property Resources (CPRs): meaning and characteristics of CPRs –
Externalities: meaning and types - positive and negative externalities in agriculture,
17. Inefficiency and welfare loss, solutions, Important issues in economics and management of
common property resources of land, water, pasture and forest resources.
Practical Schedule
1. Preparation of farm layout. Determination of cost of fencing of a farm.
2. Computation of depreciation and cost of farm assets: Valuation of assets by different
methods.
3. Application of equi - marginal returns / opportunity cost principle in allocation of farm
resources.
4. Determination of most profitable level of inputs use in a farm production process.
5. Determination of least cost combination of inputs.
6. Selection of most profitable enterprise combination.
7. Application of cost principles including CACP concepts in the estimation of cost of
cultivation and cost of production of agricultural crops.
8. Estimation of cost of cultivation and cost of production of perennial crops / horticultural
crops.
9. Estimation of cost of returns of livestock products.
10. Preparation of farm plan and budget.
11. Farm records and accounts: Usefulness, types of farm records: farm production records
and farm financial records.
12. Preparation of Cash flow statement
13. Preparation and Analysis of Net worth Statement and Profit and Loss statement
14. Estimation of Break – even analysis.
15. Graphical solution to Linear Programming problem.
16. Collection and analysis of data on various resources in India.
17. Final Practical Examination.

References
1. Sankayan, P.L. 1983. Introduction to Farm Management. Tata McGraw Hill Publishing
Company Ltd. New Delhi.
2. Johl, S.S & Kapoor, T.R. 1973. Fundamentals of Farm Business Management. Kalyani
Publishers. Ludhiana.
3. Kahlon, A.S and Singh K. 1992. Economics of Farm Management in India. Allied
Publishers. New Delhi.
4. Doll, J.P. and F. Orazem. 1983. Theory of Production Economics with Applications to
Agriculture. John Wiley, New York.
5. Debertin, D.L. 1986. Agricultural Production Economics. Macmillan. New York.
6. Heady, E.O. and H.R. Jensen. 1954. Farm Management Economics. Prentice – Hall.
Englewood Cliffs.
7. Kay, Ronald D., and William M. Edwards, and Patricia Duffy. 2004. Farm Management.
Fifth Edition. McGraw–Hill Inc. New York.
8. Panda, S.C. 2007. Farm Management and Agricultural Marketing. Kalyani Publishers.
Ludhiana. India.
 Lec. No.: 1
Meaning and concept of farm management, objectives and relationship with
other sciences. Meaning and definition of farms, its types and characteristics,
factors determining types and size of farms
FARM MANAGEMENT
Meaning
Farm Management comprises of two words i.e. Farm and Management. Farm means a piece
of land where crops and livestock enterprises are taken up under common management and has
specific boundaries.
Farm is a socio economic unit which not only provides income to a farmer but also a source
of happiness to him and his family. It is also a decision making unit where the farmer has many
alternatives for his resources in the production of crops and livestock enterprises and their disposal.
Hence, the farms are the micro units of vital importance which represents centre of dynamic
decision making in regard to guiding the farm resources in the production process.
The welfare of a nation depends upon happenings in the organisation in each farm unit. It is
clear that agricultural production of a country is the sum of the contributions of the individual farm
units and the development of agriculture means the development of millions of individual farms.
Management is the art of getting work done out of others working in a group.
Management is the process of designing and maintaining an environment in which
individuals working together in groups accomplish selected aims.
Management is the key ingredient. The manager makes or breaks a business.
Management takes on a new dimension and importance in agriculture, which is mechanized,
uses many technological innovations, and operates with large amounts of borrowed capital.
The prosperity of any country depends upon the prosperity of farmers, which in turn
depends upon the rational allocation of resources among various uses and adoption improved
technology. Human race depends more on farm products for their existence than anything else
since food, clothing– the prime necessaries are products of farming industry. Even for industrial
prosperity, farming industry forms the basic infrastructure. Thus, the study farm management has
got prime importance in any economy particularly on agrarian economy.
Definitions of farm management.
1. The art of managing a Farm successfully, as measured by the test of profitableness is called farm
management. (L.C. Gray)
2. Farm management is defined as the science of organization and management of farm enterprises
for the purpose of securing the maximum continuous profits. (G.F. Warren)
3. Farm management may be defined as the science that deals with the organization and operation
of the farm in the context of efficiency and continuous profits. (Efferson)
4. Farm management is defined as the study of business phase of farming.
5. Farm management is a branch of agricultural economics which deals with wealth earning and
wealth spending activities of a farmer, in relation to the organization and operation of the
individual farm unit for securing the maximum possible net income. (Bradford and Johnson).
6. Most acceptable form: Farm Management is a science that deals with the organization and
operation of a farm as a firm from the point of view of continuous maximum profit consistent
with the family welfare of the farmer.
Nature of farm management
Farm management deals with the business principles of farming from the point of view of
an individual farm. Its field of study is limited to the individual farm as a unit and it is interested in
maximum possible returns to the individual farmer. It applies the local knowledge as well as
scientific finding to the individual farm business.
Farm management in short be called as a science of choice or decision making.
The need for managing an individual farm arises due to the following reasons:
1. Farmers have the twin objectives, viz., maximization of farm profit and improvement of standard
of living of their families.
2. The means available to achieve the objectives, i.e., the factors of production, are scarce in
supply.
3. The farm profit is influenced by biological, technological, social, economic, political and
institutional factors.
4. The resources or factors of production can be put to alternative uses.
Scope of farm management
Farm Management is generally considered to be MICROECONOMIC in its scope. It deals
with the allocation of resources at the level of individual farm. The primary concern of the farm
management is the farm as a unit
Farm management concerns with the allocation of scarce resources within the individual
farm and hence it is a micro approach. It deals with the organization and operation of individual
farm business. But agricultural economics consider the problems of farmers as a whole (macro
level). Farm management is practical oriented since it applies the facts and findings of other
agricultural sciences in the farm by selecting the suitable technologies considering the resource
availability. It integrates the findings of various agricultural sciences to solve problems. Farm
Management is concerned with profit. i.e., the economic efficiency (yield that maximizes the
profit) whereas other sciences are interested in physical efficiency i.e., maximum yield. Farm
Management tries to maximize the profit from the whole farm instead of a particular enterprise.
The scope of farm management can be viewed in terms of problem it solves. The economic
principles are employed to find answers to the problems of what to produce? How to produce? And
how much to produce? The recent development in agricultural production technologies (new
varieties, new inputs) and changes in Government policies have provided number of alternatives to
which the scarce farm resources can be allocated. The farmers are operating the business in a
dynamic environment and the principle and methods of Farm Management guide the farmers in the
decision making process.
 Farm Management research provides valuable information to the Government in the
formulation of suitable policies on factor-product pricing, farm mechanization, input supply,
marketing, farm labour etc.,
Farm Management teaching provides resource persons for farm management research,
teaching and farm management extension. Advanced training, seminars and workshop in farm
management help the farm management scientists and teachers to update their knowledge.
Farm management extension helps the farmers to improve their managerial capacity.

Relationship of farm management with other sciences

The Farm Management integrates and synthesizes diverse piece of information from
physical and biological sciences of agriculture.
The physical and biological sciences like Agronomy, animal husbandry, soil science,
horticulture, plant breeding, agricultural engineering provide input-output relationships in their
respective areas in physical terms i.e. they define production possibilities within which various
choices can be made. Such information is helpful to the farm management in dealing with the
problems of production efficiency.
Farm Management as a subject matter is the application of business principles n farming
from the point view of an individual farmer. It is a specialized branch of wider field of economics.
The tools and techniques for farm management are supplied by general economic theory. The law
of variable proportion, principle of factor substitution, principle of product substitution are all
instances of tools of economic theory used in farm management analysis.
Statistics is another science that has been used extensively by the agricultural economist.
This science is helpful in providing methods and procedures by which data regarding specific farm
problems can be collected, analysed and evaluated.
Psychology provides information of human motivations and attitudes, attitude towards risks
depends on the psychological aspects of decision maker.
Sometimes philosophy and religion forbid the farmers to grow certain enterprises, though
they are highly profitable. For example, Islam prohibits Muslim farmer to take up piggery while
Hinduism prohibits beef production.
The various pieces of legislation and actions of government affect the production decisions
of the farmer such as ceiling on land, support prices, food zones
etc. The physical sciences specify what can be produced; economics specify how resources
should be used, while sociology, psychology, political sciences etc. specify the limitations which
are placed on choice, through laws, customs etc.
Characteristics of farming as business
Farming is generally practiced in relatively small and scattered units except in the case of large
scale plantations.
1. As compared to nonfarm activities, farming is highly influenced by natural factors such as
climate, rainfall, soil etc.
2. Farm products are highly heterogeneous and maintaining uniform quality is very difficult.
3. Farm production is seasonal whereas consumption is throughout the year and the demand is
also inelastic for product such as food grains.
4. Farm products are bulky in relation to their value and some products such as fruits, vegetables;
milk etc are highly perishable resulting in high per unit cost of marketing.
5. Many farm products are produced as joint products (Eg) grain and straw, cotton seed and lint
and hence it is somewhat difficult to distribute the costs and returns between the joint
products.
6. In farming the time lag between investments and getting returns is generally larger compared
to nonfarm activities?
7. Land is the most important asset for farmers and a major share on total investment is on land.
8. Farmers are price takers both in factor and product markets since the contribution of individual
farmer to total supply of products or demand for factors is negligible.
9. Generally, farmers are owners of land and other fixed assets and they are also the managers
of the farm business performing various function.
10. Indian farming is semi commercialized. Farmers produce for the market and also to meet their
family requirement.
Agricultural Production Economics vis-a-vis Farm Management

Following are the differences between agricultural production economics and farm management.
Agricultural Production Economics Farm Management
It is a science in which the principles of It is a science of organization and operation of
choice are applied to use of land, capital, labour farm with a view to earn continuous profits
and management of resources in the farming
industry
Agricultural production economics is a It is an integral part of agricultural
specialized branch of agricultural economics production economics

It is microeconomic in its scope as it deals It is microeconomic in its scope as it is

with the problems of farming industry concerned with the problems of individual
farm
It deals with allocative efficiency of It deals with economics efficiency at the farm
the use of resources in agriculture level
.
 Lec. No. 2:
Types of farming: Specialized, Diversified, and Mixed farming – Systems of farming:
Peasant Farming, State Farming, Capitalistic, Collective and Co – operative Farming.
A. CLASSIFICATION OF FARMING
Farming may be classified on the basis of similarity in i) combinations of
products, crop and livestock raised and i i) the mode of economic and social
functioning - private, co-operative, state or collective, etc. It is concerned with the
organizational set up under which the farm is being run. Systems mainly deal with
questions like i) who is the owner of the land, ii) whether the resources are pooled
or used individually, and iii) who makes the managerial decisions. It is classif ied
into five groups, namely, peasant, co-operative, state, capitalistic and collective
farming.
When farms in a group are quite similar in t he kinds and productions of the
crops and livestock that are produced and the methods and practices followed in
production, the group is described as type of farming. It includes specialized,
diversified, mixed and ranching.
I) TYPE OF FARMING
The type of farming refers to the nature and degree of product or
combination of products being produced and the methods and practices used for
them

a) Specialized Farm: Specialization means that the farmers specialize in one

enterprise such as crop, dairying, poultr y or tea estate, etc and this commodity is
the only source of income, the farm is said to be specialized . Examples are
sugarcane farm, cotton farm, po ultry farm, dairy farm, wheat farm etc.
.1) Advantages of specialized farming
i) Better use of land: It is more profitable to grow a crop on a land best suited to
it. E.g.) Jute cultivation on a swampy land.
ii) Better Marketing: Specialization allows for better assembling, grading,
processing, storing, transporting and financing of the produce.
iii) Better Management: As there are fewer enterprises, wastage can easily be
detected and they can be better managed.
iv) Less equipment and labour are needed.
v) Costly and efficient machinery can be used.
vi) Efficiency and skills are increased: Specialization allows a man to be more
efficient and expert at doing a few things.
2) Disadvantages of specialized farming
i) There is a greater risk - failure of crop and market together may ruin the
farmer.
 ii) Productive resources – land, labour and capital are not fully u tilized.
iii) Fertility of soil cannot be properly maintained due to lack of suitable
rotations.
iv) By products of the farm cannot be fully utilized due to lack of sufficient
livestock on the farm.
v) Farm returns in cash are not generally received more t han once in a year, i.e.,
there is no regular farm return.
b) Diversified Farming
When a farm is organized to pro duce several products (commodities), each of
which is itself a direct source of income, the farm business is said to be
diversified. A Farm on which no single or source of income yields 50 per cent of
the total receipt.
1) Advantages of diversified farming
i) Better use of land, labour and capital: Better use of land through adoption of
crop rotations, steady employment generation and more effi cient use of equipment
are obtained.
ii) Business risk is reduced due to a crop failure or unfavorable market prices.
iii) Regular and quicker returns are obtained from various enterprises.
iv) proper utilization of by products
2) Disadvantages of diversified farming.
i. Because of varied jobs in diversified farming, a farmer can efficiently supervise
only limited number of workers.
ii. Marketing problems.
iii. Not economical to maintain costly machinery.
c) Mixed Farming
Mixed farming is a type of farming under which crop production is combined
with livestock rearing. The livestock enterprise is complementary to crop
production programme so as to provide a balanced and productive system of
farming. In mixed farming, the contribution of livestock activities to gross fa rm
income should be a minimum of 10 per cent and a maximum of 49 per cent.
1) Advantage of Mixed Farming
i. Maintenance of soil fertility.
ii. Proper use of by products
iii. Facilitates intensive cultivation
iv. Milch animals provide drought animals
v. Draught animals are used in crop production and transport.
vi. It provides regular income and employment.
d) Ranching
The practice of grazing animals on public lands is call ed ranching. The
livestock graze the natural vegetation. Ranch land is not utilized by tilling or
raising crops. The ranchers have no land of their own and make use of the public
grazing land. Ranching is followed in Aust ralia, America, Tibet and certain p arts
of India (Bikaner in Rajesthan).
V. A. Dry farming: Cultivation of crops in regions with annual rainfa ll of less
than 750 mm. Crop failure is most common due to prolonged dry spells during
crop period.
B. Dry land farming: Cultivation of crops in regions with annual rainfall of more
than 750mm. Moisture conservation practices are necessary for crop produc tion.
C. Rain fed farming: Cultivation of crops in regions with an annual rain fall of
more than 1150 mm.
e) Determinants of Type of Farming
The type of farming is determined by 1) Physical, 2) Economic and 3) Social
factors.
1) Physical Factors: The physical factors namely climate, soil and topography
have influence in determining the type of farming.
2) Economic Factors:
i. Marketing cost
ii. Relative profitability of enterprises
iii. Availability of capital
iv. Availability of labour
v. Land values
vi. Cycles over and under production
vii. Competition between enterprises
viii. Personal likes and dislikes of farmer
ix. prevalence of pest and diseases, etc.
3) Social Factors: The kind of people in the community and the provision of
protection of crops against the hazards of bird and animal ra vages may influence
the farming community to change the pattern of cropping. The co -operative spirit
in providing security to crops, benefits resulti ng from low transport costs through
collective sale and better marketing facilities permit farmers to expan d some
enterprises like fruit farming, dairying or poultry rearing.
II) SYSTEM OF FARMING
The system of farming refers to the organizational set up under which farm
is being run. It involves questions like who is the owner of land, whether
resources are used jointly or individually and who makes managerial decisions.
Systems of farming, which are based on different organizational set up, may
be classified into five broad categories:
i) Co-operative Farming
Co-operative farming means a system under whic h all agricultural
operations or part of them are carried on jointly by the farmers on a voluntary
basis in order to exploit modern cultivation pract ices and economies of scale. The
working group on co- operative farming defines a co -operative farming society as
“a voluntary association of cultivators for better utilization of resources
including manpower and pooled l and and in which majority of the members
participate in farm operation with a view to increasing agricultural production,
employment and income.”

Co-operative farming societies have four different forms:

a) Forms of co-operative Farming: There are four different forms of co-
operative farming. They are: Co-operative Better farming, Co-operative Joint
farming, Co-operative Tenant farming and Co-operative Collective farming.
1) Under the system of co-operative better farming, the land is not pooled and
cultivation is carried on by each farmer separately. The co-operative better
farming society promotes the interest of the members through the adoptio n of
better farming practices. It arranges for the purchase of seeds, manure, joint use of
machinery etc. A member is free to follow his own way of f arming except in
respect of the purpose for which he joins the society, e.g. irrigation, purchase of
seeds or marketing of produce, etc.
2) Co-operative Joint farming: Under this type, the right of individual
ownership is recognized and respected but the small owner’s pool their land for
the purpose of joint cultivation. The ownership is individual but the operations
are collective. The management is democratic and is elected by the members of
the society. Each member working on the farm receives daily wages for his daily
work and profit is distributed according to his share in land.

3) Co-operative tenant farming: Such societies are usually organized by landless

farmers. In this system usually land belongs to the society. The land is divided
into plots which are leased out for cultivation to individual members. The society
arranges for agricultural requirements eg: credit, seeds, manures, marketing of the
produce etc. Each member is responsible to the society for the paymen ts of rent on
his plot. He is at liberty to dispose of his produce in such a manner as he likes.
4) Co-operative collective farming: Both ownership and operations under this
system are collective. Members do not have any right on land and they cannot
take farming decisions independently but are guided by a supreme general body.
It undertakes joint cultivation for which all members pool their res ources. Profit
is distributed according to the labour and capitals invested by the members.

ii) Collective Farming

In collective farming, the members surrender their land, livestock and dead
stock to the society. The members work together under a manageme nt committee
elected by them. The committee allocates work to members, distributes income
and market surpluses and puts all members into labour to se e that the work is
done. The main source of income is through labour earnings. Collective farming
has come into much prominence and has been adopted by

some countries notably by the Russia and China. The worst thing with this system
is that the individual has no voice. Farming is done generally on large scale and
thereby is mostly mechanized. This system is no t prevalent in our country.

iii) Capitalistic Farming

In what is known a s capitalistic or estate or corporate farming, land is held in large
areas by private capitalists, corporations or syndicates. Capital is supplied by one or a few
persons or by many, in which case it runs like a joint stock company. In such farms, the
unit of organization is large and the work is carried on with hired labour; latest technical
knowhow is used and extensive use of machines are made and hence they are efficient.
Examples of this type of farming are frequently found in USA, Australia, Canada and few
in India too. Such types of farms have been organized in the states of Bombay, Madras and
Mysore for the plantation of coffee, tea and rubber and sugarcane.

The advantages of such farming are good supervision, strong organizational set
up, sufficient resources etc. Their weaknesses are that it creates socio-economic
imbalances and the actual cultivator is not the owner of the farm.
iv)State Farming
State farming as the name indicates is managed by the government. Here land is
o w n e d b y t h e s t a t e . The o p e r a t i o n and management is done b y government officials.
The state performs the function of risk bearing and decision making, which cultivation is
carried on with help of hired labour. All the labourers are hired on daily or monthly basis
and they have no right in deciding the farm policy. Such farms are not very paying because
of lack of incentive. There is no dearth of resources at such farms but sometimes it so happens
that they are not available in time and utilized fully.
v) Peasant farming: This system of farming refers to the type of organization in which an
individual cultivator is the owner, manager and organizer of the farm. He makes decision and
plans for his farm depending upon his resources which are generally meager in comparison to
other systems of farming. The biggest advantage of this system is that the farmers himself is
the owner and therefore free to take all types of decisions. A general weakness of this system is
that the resources with the individual are less. Another difficulty is because of the law of
inheritance. An individual holding goes on reducing as all the members in the family have
equal rights in that land.
Table 13.1 Characteristics of Types of Farming

S.No. Types of Farming Type of Type of

Ownership Operationship
I Co-Operative Farming
1. Co-operative Better farming Individual Individual
2. Co-operative Joint farming Individual Collective
3. Co-operative Tenant farming Collective Individual
4. Co-operative Collective Collective Collective
farming
II. Collective Farming Society (or) State Society (or)
State
III. Capitalist Farming Individual Individual
IV. State Farming State Paid
Management
V. Peasant Farming Individual Individual
 Lecture No. 3.
Principles of Farm Management: Concepts of Production Function and its
characteristics and its types, use of production function in decision making on a farm
Some of the economic principles that help in rational farm management decisions are;
1. Law of variable proportions or Law of diminishing returns: It solves the problems of
how much to produce? It guides in the determination of optimum input to use and
optimum output to produce. It explains the one of the basic production relationships viz.,
factor- product relationship
2. Cost Principle: It explains how losses can be minimized during the periods of price
adversity.
3. Principle of factor substitution: It solves the problem of ‘how to produce?. It guides in
the determination of least cost combinations of resources. It explains factor-factor
relationship.
4. Principle of product substitution: It solves the problem of ‘what to produce?’. It guides
in the determination of optimum combination of enterprises (products). It explains
Product- product relationship.
5. Principle of equi-marginal returns: It guides in the allocation of resources under
conditions of scarcity.
6. Time comparison principle: It guides in making investment decisions.
7. Principle of comparative advantage: It explains regional specialization in the production
of commodities

Production function

The mathematical expression of technical relationship between input and output is

known as production function. It indicates the amount of output obtained from a given
amount of input, at a given level of technology during given period of time. Since the amount
of output depends on the quantities of input(s), the output is a dependent variable and inputs are
independent variables. For example, the output of rice depends on the area under rice (land),
quantity of seeds (plants), water, manures, fertilizers, human labour, and other inputs applied
during the production process. The relationship between rice yield and the inputs can be written
as.
R = f(L,S,W,M,F,H)
 Where, R = rice output, L,S,W,M,F and H represent the input-land, seeds, water,
manures, fertilizer and human labour, respectively. Traditionally the alphabet ‘Y’ is used to
denote output and ‘X’ to denote input
Y = f(X1, X2, X3, X4, X5,X6,),
Assumptions of Production Function Analysis
1. The production function is defined only for the non-negative values of inputs and outputs.
2. The production function presupposes technical efficiency. This means that every possible
combination of inputs is assumed to result in maximum level of output.
3. The input- output relationship or the production function is single valued and continuous.
4. The production function is characterized by i) decreasing marginal product for all factor
product combinations; ii) decreasing rate of technical substitution between any two factors;
and iii) an increasing rate of product transformation between any two products.
5. The returns to scale are assumed to be decreasing.
6. All the factors of production and products are perfectly divisible.
7. The parameters determining the firm’s production function do not change over the time
period considered. Also, these parameters are not allowed to be random variables.
8. The exact nature of any production function is assumed to be determined by a set of
technical decisions taken by the producer.
Short run production function vs long run production function
Short run production function is obtained when at least one input is held at constant
level – one input is fixed. In the production function Y=f(X1,X2,/X3), the inputs before/ie X1
and X2 are variable and X3(land) is fixed. This means that the output ‘Y’ can be increased by
increasing labour and capital inputs when land areas is held at constant level. The long run
production function is one in which all inputs are variable. In the long run, producers can
increase the output by increasing all inputs.

Continuous Vs discontinuous production function

Continuous production function is obtained when inputs can be split and applied in
minute quantities; for example fertilizers can be applied even in grams. When inputs can be
applied only in whole numbers (lumpy inputs) the resultant production function is a
discontinuous one ie, one can shift from one point to another. Eg. Number of cows vs milk
production.(Fig 2.1& 2.2)
 Discrete Production Continuous Production

A production function can be presented in a tabular from (arithmetical form) or geometrical

(graphical) form) or algebraic form (mathematical) equations.
Different Forms of Production Function

i) Linear Production Function

Y = a + b1x1 + b2 x2 + b3 x3…..+ bn xn
Where x1, x2,……xn are inputs Y = output, b1, b2, ….. bn are coefficients / marginal
products. This function shows the constant rate return.

Example Estimated Equation

Y = 1300 + 5 X
This shows that 1300 kg of product can be produced without applying input. And the
output increases by 5kg for every increase of 1kg of input.

ii) Quadratic Form

Y = a+ bx - cx2
The simple quadratic equation with a minus before ‘C’ to denote diminishing marginal
returns. It allows both declining and negative marginal productivity.

dy
Marginal Product = = b − 2cx
dx
Max TPP is obtained when X= 0.5bc-1
The elasticity is not constant but it declines with input magnitude. The elasticity equation is
given below.
 bx − 2cx 2
Ep =
a + bx + cx 2

If there are two inputs the function will be

Y = a + b1 X1 + b2 X 2 − b3 X12 − b4 X 22 + b5 X1 X 2

Diminishing marginal returns exists for either factor alone but there is positive interaction
between the two factors. (Negative or Zero interaction also may exist where diminishing
marginal returns hold true for both factors).

iii) Cobb-Douglas or power function

Y = axb

Where x is the variable resource measured

Y is output
‘a’ is a constant and ‘b’ defines the transformation ratio when x is at different magnitudes.
The exponent or ‘b’ coefficient is the elasticity of production and can be used directly. The
equation is estimated in logarithmic form. The function allows either constant, increasing or
decreasing marginal productivity. It does not allow an input-output curve embracing all three.

dy baX b
MP = = baX b−1 =
dx X

iv) Mitscherlich or Spillman function

v) Transcendental function
vi) Translog PF
vii) Constant elasticity of substitution (CES) function
viii) Resistance Function
ix) Square root PF: It represents a compromise between C-D & the quadratic PF.:

This function gets rid of the limitations of field mix of inputs for producing different levels of
output inherent in the C-D production function & that of linear isoclines in quadratic function.
Thus, this function allows both a diminishing TP in the same way as QF does & for declining
MPs at a diminishing rate as the C-D function does.
Farm Management decisions:
Farm management is a science of decision making or a science of choice. A farmers or a farm
manager has to undertake a variety of decisions. Farm management decisions may be grouped
under three major categories.

A Classification of FMD, based on the following characteristics of decision:

1. Importance: Certain decisions have more impact on cost and returns than other
decisions. Measured generally through the magnitude of profit or loss involved.
Example selecting poultry as farm enterprise is more importance than the location of
poultry shed.

2. Frequency: Many Farm management decisions are taken more frequent and repetitive
nature. Eg: feeding for poultry, fish or animal.
3. Imminence. It refers to the penalty or cost of waiting. Some decision can be postponed
while other cannot be postponed. Eg: decision to harvesting paddy is much more
imminent than a decision about buying a tractor.
4. Revocability: Some decisions can be easily reversed, whereas others can be changed
only at considerable expenses. Eg. Relatively easier to replace paddy with groundnut,
which perhaps became more profitable, than to convert a mango orchard into a
sugarcane crop.
5. Alternatives available: The decisions become more complicated as the number of
alternatives increase. Eg: Threshing of paddy can done manually or using thresher.
B. Factors influencing Farm management decisions:
Farm management decisions undergo continuous change over time because of the changing
environment around the farm, farmer and his family.
a. Economics factors like price of input and outputs
b. Biological characteristics of plants and animals
c. Technological factors like technology advancement and varietal suitability for
different agroclimatic condition.
d. Institutional factors: infrastructural facilities includes storage, processing, grading,
transport, marketing of input and output. Govt. polices on farm practices, input
subsidies, taxes, export and import policies, procurement and pricing policies.
e. Personal factors: like customs, attitude, awareness personal capabilities.
C. Methods of decision making:
Every farmer/ manager has to make decisions about his farm organization and operation
from time to time. There are three method of decision making.
a. Traditional method: decisions are influenced by traditions in the family or region or
community
b. Technical method: Use technical knowledge. Eg: Quantity of Nitrogen requirement for
maximum yield.
c. Economic method: All the problems are considered in relation to the expected costs and
return. It is best method since the objective of Farm management is to max farm profit as
whole.
2: Steps in decision making
Every farmer has to make decisions about his farm organization and operation from
time to time. Decisions on the farms are often made by the following three methods: The
concept of management as a decision making process /procedure relates to the scientific
method of problem solving. It involves the following eight steps.

method of problem solving. It involves the following eight steps.

1 Setting of goals or • Goals should be realistic, attainable and specific

objectives • Recognize the multiple and shifting nature of goals
• Have a hierarchy of goals – goals have different weights
• Recognize the time dimension of goals - short term & long
term goals.
2 Recognition and definition • Select a problem/opportunity when solved promise a high pay
of problem/opportunity – off in terms of a goal
• Understand the relative importance and urgency of the problem
3 Gathering & Organization • Many ways to solve a problem and thus many sets of data
of facts • Determine the more important information
• Source: neighbors, Govt. agencies, Agrl. Universities, input
supplying, firms, marketing, agencies, newspapers, magazines,
market reports, Farm records etc
4 Analysis • Technical and economic relationships
• Recognize the qualitative factors and rank them
• Analysis may be supplemented with intuition and tempered
with judgment based on experience – Art of management
• Consider the consequences of the alternatives
5 Decision making • Select the alternative that appears more desirable and
consistent with the goal of the business, resources and strength
and weakness of the business
6 Implementation (Acting on • Commit resources
decisions) • Supervise and Monitor
• The ability to adjust the plan of execution is an important part
of successful decision implementation
7 Acceptance of • The outcome may be good or bad,
responsibility • The farmer must bear the consequences
8 Evaluation • Assess the impact of the decision
• Did the outcome approximate the expectation? If not, why?
What are the factors responsible for the gap?
• Have these factors been considered in the analysis?
• If not, are they sufficiently important to be included in the next
time when similar decision is made?
• Is the farmer satisfied or a new activity called for?
Source: Osburn, D.D. and Schneeberger, Modern Agriculture Management,
1978 PP. 9-14
Steps in Decision Making

FORMULATING OBJECTIVES AND MAKING OBSERVATIONS

ANALYSIS OF OBSERVATIONS

YES
ARE MORE
OBSERVATIONS
NEEDED?

NO
DECISION MAKING

IS THE DECISION
FINAL?
NO
YES

ACTION TAKING

ACCEPTING RESPONSIBILITIES

YES
HAVE THE MANAGEMENT
NO OBJECTIVES BEEN FULFILLED?

THE END
 Lec.No. 4: Factor-Product relationship: Meaning - agricultural Production Function:
Meaning – Definition- Laws of returns: increasing, constant and decreasing returns
The concept of Marginalist

The words marginal, additional, incremental, rate of change or slope are often used to
denote changes in inputs, outputs, costs, revenue etc. the symbol  is used to denote marginal
changes. The term ‘margin’ deals with changes in variables with respect to unit change in other
variables. The marginalism principle is very much useful in deciding the enterprise
combination (what to produce), combination of inputs-selecting the technology (how to
produce) and the level of output (how much to produce).
The objective of factor-product relationship is to determine the optimum quantity of the
variable input that will be used in combination with fixed inputs in order to produce optimal
level of output. Further questions such as, how much fertilizer to be applied per acre? how
much irrigation to be given? and so on are all within the scope of factor – product relationship.
There can be three types of input-output relationships in producing a commodity where one
input is varied and the quantities of other inputs are fixed. The nature of relationships between
a single input and a single output can either be of the one or a combination of types given
below:
i) Constant Marginal Rate of Returns or Law of Constant Returns.
ii) Increasing Marginal Rate of Returns or Law of Increasing Returns.
iii) Decreasing Marginal Rate of Returns or Law of Decreasing Returns.
A. LAWS OF RETURNS
Let us consider the simplest case where one product is produced by varying the level of
only one factor of production at a time.

i) Law of Constant Returns: Mathematically, it can be expressed as:

Y1 Y2 Y Yn
The level of output increases by an = = .... = i = ... = =k
equal amount for each additional units of X 1 X 2 X i Xn
the variable input i.e., the relationship
between the input and the output is linear.
In other words addition to total product is at
constant rate. Thus, graphically, the law of
constant returns can be depicted by a
straight-line production function. The
production function has the same slope
throughout its entire range as shown in the
figure 10.1.
Where Yi /Xi is the marginal product due to the use of the ith unit of variable input, X ( i =
1, 2,…,n ) and k is a constant. Such constant returns can occur under two situations:
a) No resource is fixed and all the inputs are varied, increa sed or decreased
together
b) One or more factors of production may be fixed but they have sur
plus (unutilized) capacity. The constant returns may be explained with the data
given below:
Constant rate of return
X Y X Y
0 0 - -
1 5 1 5
2 10 1 5
3 15 1 5
4 20 1 5
5 25 1 5
When the variable input (X) is increased by equal amount the total output (Y) increases
at constant rate. In the given example, each successive unit of variable input adds 5 units of
output to total product. The marginal product (  Y/  X) of each unit of input is same ie. 5
units. ie, at the rate of 5 units/unit of input. It has limited application in agriculture example
each addition of one acre of land will add the same amount of product. This constant
relationship can be illustrated with a graph as in Fig 2.3(a) the production function is a straight
line having the same slope throughout its entire range. This relationship can also be expressed
as:
Y11 Y12 Y1n
= ........ =
X 11 X 12 X 1n

ii. Increasing rate of return

Every additional or marginal unit of input adds more to the total product than the
previous unit; i.e., addition to total product is at an increasing rate. Increasing returns are said
to operate when every successive unit of the variable input results in a larger increase in the
output as compared to the preceding unit. Such an input-output relationship is generally
encountered at a relatively lower level of input use. The resulting production function is a non-
linear curve of the type shown in the figure 10.2 and is convex to the input axis.
Y1 Y2 Yi Yn
Mathematically, the law can be stated as under:   ....   ... 
X 1 X 2 X i Xn

.X Y X Y

0 0 - -

1 5 1 5

2 11 1 6
 3 18 1 7

4 26 1 8

5 35 1 9

Law of increasing returns

In the above example, each unit of

input (X) adds more to the total output than
the previous unit. The total output increases
at increasing rate. The marginal product of
the first unit of input is 5 while the
additional output produced by 2nd, 3rd, 4th
and 5th units of input are 6,7,8 and 9
respectively indicating increasing marginal
physical product. This increasing
relationship can be illustrated with a graph
as in Fig 2.3(b) the shape of the curve will
go steeper and steeper with the added
inputs i.e., slope gets convex to the origin.
This relationship can also be expressed as:

Y11 Y12 Y1n

 .  ....... 
X 11 X 12 X 1n

iii. Diminishing rate of return

Every additional or marginal unit of input adds less to the total product than the
previous unit; i.e., addition to total product is at Decreasing rate.
Diminishing rate of return
X Y X Y
0 0 - -
1 6 1 6
2 11 1 5
3 15 1 4
4 18 1 3
5 19 1 1
 If each successive units of input (X)
adds less and less to the total product than
the previous unit, the relationship is termed
as diminishing rate of return. The MPP of
each successive unit of input decreases, i.e.
the total output increases at diminishing
rate. It could be seen from table that the
first unit of input adds 6 units of output
whereas the 2nd adds 5 units; the 3rd, 4th and
5th units produce an additional output of 4,
3 and 1 unit, respectively. This Decreasing
relationship can be illustrated with a graph
as in Fig 2.3(c) the curve is the concave to
the origin. This relationship can also be
expressed as:

Y11 Y12 Y1n

  ....... 
X 11 X 12 X 1n

In agricultural production, the type of input output relationship, generally, observed is

the diminishing rate of return.

Law of diminishing marginal returns (LDMR)

Alfred Marshall stated the law thus: “An increase in labour and capital
applied in the cultivation of land causes, in general, a less than proportionate
increase in the amount of produce raised, unless it happ ens to coincide with
an improvement in the arts of agriculture”.
The technology improvement will delayed the operation of this law but so far, science
has not succeeded in stopping the operation of this law of LDMR in agriculture.

The law of LDMR also called the law of variable proportions. E.O. Heady has stated
that if the quantity of one productive service is increased by equal increments, with the quantity
of other resource services held constant, the increment to total product may increase at first but
will decrease, after a certain point. In other words, as the amount of a variable resource used in
the production of an output is increased, the level of output will at first increase at an
increasing rate, then increase at a decreasing rate and finally a point will be reached, where
further applications of the variable resource will result in a decline in the total output of the
production
 Difference between the law of variable proportions and returns to scale
Sr. No. Law of variable proportions Returns to Scale
1 Describes the behaviour of output when Examine the behaviour of output when all
one input is varied. inputs are varied at the same time.
2 Some factors of production are constant. All factors are varied.
3 The proportion among factors varies. The proportion among factors remains
constant.
4 It is a short run production function. It is a long run production function.
5 Here increasing constant or decreasing Here increasing constant or decreasing
returns to a factor are observed. returns to scale are observed.
6 Increasing returns are due to the efficient Increasing returns to scale are due to scale
utilization of fixed resources as a result economies of production.
of application of sufficient quantity of
variable resource.
7 Optimum output is the result of best The optimum output is the result of
proportion among fixed & variable optimum size of plant.
factors.
8 Diminishing returns are due to over Diminishing returns to scale are due to the
exploitation of fixed factor. operation of diseconomies of scale.

9 Y = f(X1 / X2 , X3….,Xn) Y = f(X1, X2 , ….,Xn)

10 It is a reality. It is myth.

Basic concepts I
The basic concepts that are frequently used in farm management are discussed below:
Farm-Firm: Farm means a piece of land where crop and livestock enterprises are taken up
under a common management. A farm is a firm which combines resources in the production of
agricultural products on the lines of a business firm, i.e., with the objective of profit
maximization.

i) Product or Output: It is the result of the use of resources or services of resources. The
resources get transformed into what is known as output. E.g. Paddy, groundnut, sugarcane,
milk, etc.
ii) Resources or Inputs or Factors of Production: Resources are those which get consumed
or transformed into products in the process of production. Services of resources are also used
up in the production process. All agricultural resources can be classified into two types. They
are i) fixed resources and ii) variable resources.

a) Fixed resources: Level of some resources like buildings, machinery, etc. is

fixed over a production-planning period irrespective of the level of enterprises
taken up. These are called fixed farm resources, E.g. Land, building, machineries,
etc. The quantum of fixed reso urces does not change with the level of production.
Some of the resources, which are fixed during a short period, may become variable
during a long term.
b) Variable resources: Some resources like seed, fertilizer, labour, etc vary with
the level of output. These are variable resources.
Resources can also be classified into stock and flow resources as de tailed
below:
a) Stock resources: They are resources which are used up entirely in the
production process. Fertilizer, seed, feed, etc., are such resources that can be
stored up for using at later period.
b) Flow resources: Contrary to stock resources, th ere are factors of production
which give only flow of services in the production process. Hence, they are called
the flow resources. If the services of this category of resources are not utilized,
they go waste, as they cannot be stored up for later use. F or example, if the
services of a farm building or machinery are not used in a particular day, they go
waste, as they cannot be stored up for future use.
iii) Ways of Mobilizing Farm Resources: The different types of farm resources
and ways of mobilizing them by a farm manager are discussed here.
a) Owning: Resources like land, machinery, implements, tools, work bullocks,
etc, can be acquired by purchasing the m. Farmers can own these resources due to
the following reasons:
1) The resources are to be continuously or more frequently used throughout the
year. The size of holding should be large enough to effectively use such assets.
2) If the farmer could not engage work bullocks, tractors / power tillers, power
sprayers, bullock cart, etc in his own farm econom ically, adequate demand should
be there for hiring out these resources.
3) The farmer should have either adequate owned funds or borrowed funds to
acquire these resources.
Owning of resources would be convenient to the farmer especially during peak
season so as to carry out the farm operation in time . However, during lean season,
it may be uneconomical to maintain owned resources. E,g. Bullocks, thresher, etc .
Hiring would be cheaper than owning the resource especially, when the size of
holding is too small.
b) Leasing: The immovable resources like la nd and buildings can be acquired by
leasing. Rent has to be paid based on the terms agreed by the lessees (tena nts) to
the owner of such resources. The land owner may lease -out his lands to land less
agricultural labourers or to farmers who are capable of cultivating larger area. The
land owner leases out due to 1) his absenteeism at the village where his land is
located, 2) inefficiency in running farm and 3) running of other more profitable
enterprise in the same village. Sometimes, the widows and invalid s may lease out
due to their physical inability. Leasing -in helps lessees (tenants) to augment their
farm returns. However, leasing-out becomes complicated due to improper
implementation of agrarian laws which are more favourable to tenants. The
fertility status of the leased-out land is gradually deteriorating because the tenants
do not apply organic manure and th ey do not properly maintain the farm assets out
of the fear of eviction from the land by the owner. Therefore, the productivity of
leased-out land is lesser than that of owned land. On the contrary, as the tenancy
legislations are more favourable to tenant s, some of them refuse to surrender their
tenancy rights to the owners and hence, the owners are rel uctant to lease out their
lands.
c) Hiring: The farmer can acquire human labour and bullock power through
hiring. The magnitude of employment of hired huma n labour and bullock power
depends upon: a) size of farm holding, b) number of family labourers avai lable, c)
availability of owned bullocks, d) resourcefulness of the farmer to replace labour
with capital and e) diversification of crop activities practice d in the farm. Hiring
of human labour and bullock power is also difficult and costly during peak sea son
due to either costly human labour as a result of heavy demand for such labour or
difficulty in carrying the operations with human labour in time. Howeve r, hiring
of human labour and bullock power is more economical than that of hired
machinery to small and marginal farms, especially in areas wher e the labour is
cheaper.
d) Joint ownership: When the land, buildings and well are inherited by legal
heirs, the land gets sub-divided and buildings and wells are jointly owned among
them. Joint ownership is convenient and economical to those who have smal l and
fragmented inherited land. However, disputes arise due to lack of understanding
among joint owners in sharing the services and also in the maintenance of the
jointly owned assets.
e) Custom Services: Farmers could acquire custom services of machineri es like
tractor, power tillers, threshers, power sprayers, etc. by paying custom hire
charges. Hiring of custom services of machineries depends upon 1) size of farm
holding, 2) availability of alternatives such as human labour and bullock power, 3)
hire charges for human labour and bullock power, 4) custom hire charges, 5) time
of operation (peak or lean season), 6) availability of time to carry out the farm
operation and 7) quantum of work to be carried out. Cus tom services would be
more economical for small and marginal farms as they cannot afford to buy or
maintain costlier equipments and machineries.
iv) Product or Output: It is the result of the use of resources or services of
resources. The resources get transformed into what is known as output. E.g.
Paddy, groundnut, sugarcane, milk, etc.
v) Production: It is a process of transformation of resources or inputs like labour,
seed, fertilizer, water, etc. into products like paddy, wheat etc.
vi) Transformation or Production Period: The time required for a resource to be
completely transformed into a product is called transformation or production
period. E.g. Paddy is harvested in 3½ to 6 months.
vii) Production Economics: Farm production economics is a field of
specialization within the subject of agricultu ral economics. It is concerned with
choosing of available alternatives or their combinations in order to maximi ze the
returns or to minimize the costs. Agricultural production economics is an applied
field of science, wherein the principles of choice are a pplied to the use of land,
labour, capital and management in farming. The subject matter of production
economics explains the conditions under which the profit, output, etc. that can be
maximized and the cost, use of physical inputs, etc. that can be minim ized.
The main objectives of production economics are:
a) to determine and define the conditions which provide for optimum use of resources;
b) to determine the extent to which the current use of resources deviates from
the optimum use;
c) to analyze the factors which influence the existing production patterns and
resources use; and
d) to identify the means and methods for optimal use of resources.
The principles that help attain these objectives are the same on a micro as on a
regional or national level. On micro level where intra-farm resource allocation and
production pattern are involved, it is the subject matte r of farm management.
When choice principles involve a broader field on a macro -level, the subject is
known as production economics. The economi st who focuses his attention on
individual farm cannot make rational recommendations unless he considers the
aggregate or overall aspect of production. Similarly, government programmes and
policies affect the decisions on the individual farms. Production e conomist,
therefore, must be able to integrate both individual and aggregate aspects of
agricultural resource use and levels and patterns of production.
Classical production function and three stages of production –Elasticity of production
 The production function, exhibiting three stages of production, has been the traditional
or standard approach for studying the economics of production and hence it is termed
‘Classical production function”. But, it may not be always possible to find all the three stages
of production in the experimental data unless the variable input is a crucial one (ie., which is a
must for production, eg: seeds) there may not be a zero production.
For the analysis of the production function Marginal Physical Product (MPP) and
Average Physical Product (APP) are derived from the Total Physical Product (TPP).

TPP: It is the quantity of physical output (Y) obtained at different levels of variable input (X).

MPP: It is the additional output from each successive unit of variable input or it is the change
in the TPP (Y ) with respect to one unit increase in variable input (X ) ie Y / X .

MPP is the slope of TPP curve. It

indicates the rate at which TPP increases
when variable input increases. When the
MPP (slope) is calculated between two
points on the TPP, it is known as average of
two slopes. On the other hand, the slope
(MPP) at a particular point on TPP is called
exact MPP. The value of average MPP are
written midway between two successive
TPP values.

APP: It is the average amount of output

produced per unit of input at a particular
level of input. It is expressed as a ratio of
output to input (Y/X) and calculated by
dividing the TPP by the number of units of
variable input used to produce that output.
APP indicates the average efficiency with
which a variable input is transformed in to
output.

Elasticity of production (EP). It refers to the percentage change in output in response to a

percentage change in variable input.
% change in output
Ep =
% change in input
 Y
Y X
= Y = x
X X Y
X
1 1
= MPP x Y/X=APP; X/Y=
APP APP
MPP
Ep =
APP

Though MPP and APP are expressed in physical units, Ep is a mere number without
any unit. Estimation of Arc elasticity with two point of input and output level.

When X increases from 1 to 2 units and Y increases from 5 to 11 estimate the Arc
elasticity of production.

Y ( X 1 + X 2 ) 6(1 + 2) 18
Ep= = = = 1.125
X (Y1 + Y2 ) 1(5 + 11) 16

The classical production function can be divided in to three regions.

CHARACTERISTICS OF TPP, MPP & APP

Product curve I Region II Region III Region

TPP Increases at increasing rate Increases at Decreases
and then increases at decreasing rate
decreasing rate
MPP Increases and then Decreases and Negative
decreases but > APP positive but < APP
APP Increases but<MPP Decreases and Decreases
reaches the maximum positive but >MPP positive
when intersects MPP
Ep >1 <1 but positive <0
Region –I : It starts from origin extends to the input level which results in the maximum APP,
(0 to MPP = APP)

Region –II : It extends from the input denoting maximum APP to the input unit corresponding
to maximum TPP (MPP = APP to MPP = 0)

Region –III : It extends from the input denoting maximum TPP to all inputs having negative
MPP (beyond MPP=0).

Relationship between TPP, MPP and APP

Since both MPP and APP are derived from TPP, they are closely related.

TPP and MPP: As long as MPP increases, TPP increases at increasing rate, when MPP
declines but positive, TPP increases at decreasing rate. When MPP is 0, TPP reaches its
maximum, when MPP is negative TPP decreases.
MPP and APP: The average efficiency of variable input (APP) depends on the productivity
(MPP) of each successive units of the variable input. As long as the MPP > APP, APP is
increasing, when MPP = APP, APP is at its maximum when MPP is < APP, APP declines.

Total physical product function (TPP): Y = 4X+2X 2 - 0.1X 3

Average physical product function (APP): Y /X = 4+2X-0.1X 2
Marginal physical product function (MPP): = dY / dX = 4 + 4X - 0.3X 2
( Input price Rs 26/unit and Output price Rs 5/unit)

Rational and Irrational regions of the production function:

In the first region, the average productivity of the variable input increases continuously
as more and more input units are added. So when the average productivity increases In this
stage, more use of variable input increases its physical production efficiency in combination
with fixed inputs. So it is irrational to stop increasing the use of variable input, as long as fixed
inputs are not fully utilized. For this reason, it is called irrational stage of production. Hence
region I is considered as irrational region for decision making.
In the third region, the total physical product declines because of the negative marginal
productivity of the inputs. It is not rational to add input units when the TPP decreases, even if
the input is free of cost. Application of input in the third stage results in double loss due to
increased input cost and loss due to reduced value of output. E.g.) more fertilizer dosage,
excessive irrigation, etc. would result in reduction of yield.

The second region is the rational region or decision-making region. Information on

input and output prices is necessary to decide the optimum level of input. The particular level
of input which maximizes the profit is the optimum amount of input and the corresponding
level of output is the optimum output. It is only in this region that marginal product of variable
and fixed factors are positive. Optimum point of input-use must be somewhere in this region.
Hence, it is called rational stage of production. It needs to be emphasized that this region of
rational production embodies diminishing returns phase. Both average and marginal products
are decreasing in this region

Impact of Technological Change on Production Function: Technology is the knowledge

applied by man to improve production or marketing process. The physical and value
productivities of farm resources have been changing continuously due to the constant flow of
innovations in agriculture. Technology can help producing more quantity of product per unit of
input. There can be different levels and grades of technology available to a farmer.
For example, application of fertilizer is possible with the broadcast method, band application and or
spray method. Use of same quantity of the fertilizer through different methods (technologies) will
give different yield levels. Similarly a different variety of a crop (paddy) such as white ponni, IR
20, IR 50, etc will give different yields. For the same quantity of input different yield levels can be
obtained (Y1, Y2 and Y3) using different types of technologies (T1, T2 and T3) as shown in the
figure.

The technological advances result in: i) Factor saving technologies, or cost reducing technologies,
such as development of improved tractors.

ii) Yield increasing technology – high yielding varieties and hybrid varieties.
iii) Both factor saving and yield increasing technology

Technical efficiency and economic efficiency

Technical efficiency is measured by the physical ratio of output to input. The greater the
ratio, the greater the degree of technical efficiency.
Economic efficiency is related to the objective relevant to the economic unit (Farm). If
profit is the main objective then economic efficiency is achieved when resources are used to give
maximum profit.
DECISION RULE FOR PROFIT MAXIMIZATION
Profit is the difference between total value product (TVP) and total input cost (TIC). TVP is
found by multiplying the total output (TPP) by the price/ unit of the output (Py). Total input cost
(TIC) is worked out by multiplying the total quantity of inputs (X) by the price / unit of the input
(Px). Profit = TVP – TIC. Profit is maximum when the difference between TVP and TIC is the
greater.
It is always profitable to increase the application of a variable input as long as the value of
the added output (MVP) is greater than value of added input (MIC). MVP is worked out by
multiplying added output by the price of the output (Py). MIC is calculated by multiplying the
added input unit ( x) by the price of that input (Px). The rule for profit maximization is that MVP
should be declining.
MVP = Y .Py, MIC = X .PX

Y .Py = X .Px or Y / X = Px / Py

i.e, MPP of X should be equal to the ratio of the input price (Px) and output price (Py). To
justify the application of an additional unit of input the MPP of that unit of input should be equal to
the price ratio Px/Py. For example, if Px = Rs.10 and Py = Rs.5, then Px/Py = 10/5 = 2 i.e. the price
of X is two times greater than the price of Y. Therefore, to justify the application of an additional
unit of input, the MPP of that unit of input should at least be 2 so that the value of that 2 units of
output. ie, Rs.10(2x5) will be equal to the price of the input (Rs.10.).
The optimum level of input use can also be worked by a simple method. For each level of
input use, the total input cost (TIC) and the value of the corresponding level of output (TVP) have
to be worked out and the profit, ie, the difference between TVP and TIC has to be calculated. The
particular level of input that gives the maximum profit should be selected as the optimum
level.
Types of Production functions- Linear, Cobb-Douglas and Quadratic

Different Forms of Production Function

i) Linear Production Function
Y = a + b1x1 + b2 x2 + b3 x3…..+ bn xn
Where x1, x2,……xn are inputs Y = output, b1, b2, ….. bn are coefficients / marginal
products. This function shows the constant rate return.
Example Estimated Equation
Y = 1300 + 5 X
This shows that 1300 kg of product can be produced without applying input. And the output
increases by 5kg for every increase of 1kg of input.
ii) Quadratic Form
Y = a+ bx - cx2
The simple quadratic equation with a minus before ‘C’ to denote diminishing marginal
returns. It allows both declining and negative marginal productivity.
dy
Marginal Product = = b − 2cx
dx
Max TPP is obtained when X = 0.5bc-1. The elasticity is not constant but it declines with input
magnitude. The elasticity equation is given below.
 bx − 2cx 2
Ep =
a + bx + cx 2
If there are two inputs the function will be
Y = a + b1 X1 + b2 X 2 − b3 X12 − b4 X 22 + b5 X1 X 2

Diminishing marginal returns exists for either factor alone but there is positive interaction
between the two factors. (Negative or Zero interaction also may exist where diminishing marginal
returns hold true for both factors).
iii) Cobb-Douglas or power function
Y = axb
Where x is the variable resource measured
Y is output
‘a’ is a constant and ‘b’ defines the transformation ratio when x is at different magnitudes.
The exponent or ‘b’ coefficient is the elasticity of production and can be used directly. The equation
is estimated in logarithmic form. The function allows either constant, increasing or decreasing
marginal productivity. It does not allow an input-output curve embracing all three.
dy baX b
MP = = baX b−1 =
dx X
Law of Diminishing Marginal Return (LDR)
The law of diminishing return relates to many biological and physical relationships. In
agriculture the maximum amount of output that can be produced from an activity (crop or livestock)
depends on the quantity of inputs used and the efficiency with which the inputs are transformed in
to output. The law of diminishing return concerns with the efficiency of input use and thus
determines the maximum amount of output that can be produced from an activity, for a given
technology. Though LDR explains the technical relationship between input and output it has
economic implications.
Alfred Marshall considered land as fixed input and labour and capital as variable inputs in
defining LDR. Marshall states “an increase in the capital and labour applied in the cultivation
of land causes in general a less than proportionate increase in the amount of produce raised,
unless it happens to coincide with an improvement in the art of agriculture”.

As more and more units of labour and capital are applied to a fixed area of land, the
additional output produced by each successive unit of labour and capital declines, i.e. the total
output increases at diminishing rate unless there is an improvement in the production technology.
Technological improvement will improve the productivity of inputs and the operation of LDR can
be postponed. Though Marshall considered land as the fixed input, any input(s) can be held at fixed
level. In more general terms, the LDR can be defined as follows. When successive units of one
variable input is added to a fixed level of other inputs, beyond certain level, the additional output
added by each unit of input (MPP) declines. The LDR is also known as law of variable
proportion since when a variable input is increased keeping the other inputs at fixed level, the
proportion between variable and fixed input changes.
 Lec. No 5:
Lecture No. 5. Meaning and Concept of cost, Types of costs, cost curves – and their inter-
relationship – shut down and break-even points, importance of cost in managing farm
business and estimation of Gross farm income, Net farm Income, Family labour income and
farm business income
Costs are usually computed as a function of output. The cost function shows the relationship
between costs and output. Explicitly or implicitly, most of the producers keep in mind the cost of
producing additional units of output. In general, at given level of prices, a farmer can increase his
farm income in two ways, i.e., i) by increasing production and / or ii) by reducing the cost of
production. Since cost minimization is an individual skill, degree of success in this direction
directly adds to the profits of the farm.

Short run cost function: it is the one in which certain costs are fixed.

C = f (Y) + K,
Where
C- total cost,
Y- output,
K- fixed cost
Long run cost function is one in which all costs are variable.

C = f (Y)

Cost concepts
Costs refer to the money value of effort extended or sacrifice made in producing an article or
rendering a service or achieving a specific purpose. Costs, thus, are the expenses incurred in
organizing and carrying out the production process. They include outlays of funds for inputs and
services used in production. Money value of all inputs used in the production process is termed as
the total cost. If the inputs used are represented by X1, X2,..., Xn and the respective prices by Px1,
Px2, ..., Pxn, then the total cost (TC) can be expressed as: TC = Px1.X1 + Px2.X2 + ... + Pxn Xn.
There are seven cost concepts.
i. Total cost. It is the total cost of producing a given level of output. It consists of fixed and
variable costs.
ii. Fixed costs: Costs which do not vary with the level of output during a given production
period is known as fixed costs. Since certain inputs are fixed during the production period, the
costs associated with them do not vary. Total fixed cost (TFC) is the sum of the monetary
values of fixed inputs. If F1 and F2 are fixed inputs, then TFC = F1. PF1+F2. PF2, where PF1 and
PF2 are the price / unit of F1 and F2, respectively.
In agriculture, rent for land, land revenue, interest on fixed investments, depreciation are
generally, considered as fixed costs since the value of land, buildings, machineries,
implements, tools and animals do not change in the short run. . In farming, cash fixed costs
include land taxes, rent, insurance premium, etc. Non-cash fixed costs include depreciation of
building, machineries and equipments caused by the passing of time, interest on capital
investment, charges for family labour and charges for management
iii. Variable cost: Costs which vary with the level of output is known as variable cost. Variable
cost in total (TVC) vary directly with the level of output, ie., increases when output increases
and decreases when output decreases. Variable cost is also known as prime cost, direct cost or
operating cost. Total variable cost is the sum of the monetary values of variable inputs. In other
words, the outlays of funds on seed, fertilizer, insecticide, casual labour, fuel and oil, feeds, etc,
are a few examples of variable costs. If X1 and X2 are variable inputs, then the total variable
cost is X1. Px1 + X2. Px2, where Px1 and Px2 are price per unit of X1 and X2 respectively. Total
cost curves are presented in Figure 7.1
iv. Average Fixed cost (AFC): It refers to fixed cost per unit of output. It is obtained by dividing
the total fixed cost by total amount of output.
AFC = TFC/Y

Since TFC is a constant the AFC decreases as output increases forming a rectangular
hyperbola and never shows an upward movement since it is irrational to produce in the III
region of the production function.

Fig 7.1 Total Cost Curves Fig 7.2.Average Cost Curves

v. Average variable cost (AVC): it is the variable cost per unit of output. It is computed by
dividing the TVC by the corresponding level of output.
AVC = TVC/Y. AVC is inversely related to APP, when APP increases, AVC decreases, when
APP decreases, AVC increases and when APP is at its maximum AVC is at its minimum.

vi. Average cost (AC) or Average total cost (ATC): It is the per unit cost of producing the
output, consisting of average fixed and average variable costs. ATC is computed by adding
average fixed cost and average variable cost or by dividing TC by the corresponding level of
output.
AC = TC/Y or TFC/Y + TVC/Y = AFC+ AVC

In response to increase in output the average cost curve decreases, reaches its minimum and
then goes upwards. AC curve reaches its minimum at a higher level of output than the output at
which AVC curve reaches its minimum since the rate of fall in AFC is more as compared to the rate
of increase in AVC. Once the rate of fall in AFC is lesser than the rate of increase in AVC, the AC
curve starts rising.

vii) Average Variable Cost and Average Physical Product: Average variable cost is inversely
related to verage physical product. When APP is increasing, AVC is decreasing. When APP is at its
maximum, AVC attains a minimum value. When APP is decreasing, AVC is increasing. Thus, for a
production function, APP measures the efficiency of the variable input, while AVC provides the
same measure for cost curves. When AVC is decreasing, the efficiency of the variable input is
increasing; efficiency is at a maximum level when AVC is a minimum and is decreasing when
AVC is increasing. The relationship algebraically is as follows:
TVC PxX X Px X 1
AVC = = = Px = because =
Y Y Y APP Y APP

vii. Marginal cost (MC): It is defined as the change in total cost per unit increase in output. It
is the cost of producing an additional unit of output. MC is computed by dividing the change in
total costs, TC, by the corresponding change in output, Y, i.e., MC =TC / Y. By definition,
the only change possible in total costs is the change in variable cost, because fixed cost does not
vary as output varies. Thus, TC =TVC. Therefore, MC could also be computed by dividing the
change in total variable cost by the change in output. Geometrically, MC is the slope of the TC and
the TVC curve. The shape of the MC curve is in an inverse relationship to that of MPP. For lower
levels of output, MC is decreasing while MPP is increasing. Algebraically, the relationship between
MPP and MC can be shown as
TC TVC PxX X Px
MC = = = = Px =
Y Y Y Y MPP
MC and AVC are equal, where MPP is equal to APP. For lower output levels, MC is less than AVC
and ATC and for higher output levels, MC is greater than AVC and ATC. As long as there is some
fixed costs, MC crosses ATC at an output greater than the output at which AVC is at the minimum
and MC is equal to ATC at the latter’s minimum point. MC curve will intersect the AVC and ATC
curves at their lowest point from below.
Costs need be computed and graphed for input and output amounts only in stages I and II of the
production function; stage III is an area in which no rational manager would produce. Stage II
begins at the point where MC=AVC and continues to the point where output is a maximum.

TC = 100 + 8Y - 0.4Y 2 + 0.02Y 3

TFC = 100
TVC = 8Y - 0.4Y 2 + 0.02Y 3
AVC = TVC = 8 – 0.4Y + 0.02Y 2
 AFC = TFC = 100
ATC = AFC + AVC = 100Y -1 + 8 – 0.4 Y + 0.02Y 2
MC = dTVC/dY = 8 – 0.8 Y + 0.06Y 2

Relationship between MC and Average Cost curves

The shape of the ATC curve depends upon the shape of the production function. ATC
decreases as output increases from zero, attains a minimum, and increases thereafter. ATC is
referred to as unit cost of production, i.e., the cost of producing one unit of output. The initial
decrease in ATC is caused by the spreading of fixed costs. among an increasing number of units of
output and the increasing efficiency with which the variable units is used (as indicated by the
decreasing AVC curve). As output increases further, AVC attains a minimum and begins to
increase; when these increases in AVC can no longer be offset by decreases in AFC, ATC begins to
rise. AVC reaches its lowest point earlier than ATC
Average and marginal cost curves are presented in Figure11.2 MC intersects AVC and AC
curves from below. As long as the MC is below AVC and AC, AVC and AC decreases, when MC
is equal to AVC and AC, AVC and AC reaches their minimum and when MC is above AVC and
AC, AVC and AC increase.
ix) Production curves and cost curves.
Cost curves are mirror images of the production curves when the TP is increasing at
increasing rate. TC is increasing at a decreasing rate and vice versa,. Similarly the inverse
relationship can be observed in the case of AP and MP curves, and MC and AC curves as shown in
the figure;

Production curves Cost curves

TPP TPP increasing at TC increasing TC increasing

TC
Outpu increasing an decreasing at a decreasing atan
at an rate increasing
t TPP Cost rate
increasing rate
rate

Point of inflection

Point of inflection
TFC

Output
Cost
MC
ATC

AVC

APP
Input
Outp
MPP ut
When substitution ratio is not equal t o price ratio, then,
MRS Price ratio Substitution principle
X 1 PX 2
= − Least cost combination
X 2 PX 1
Px1 X 1 PX 2 X 2
=
X 1 PX 2
> − Cost of producing given output can be reduced
X 2 PX 1 by increasing X2 and reducing X1 (LCC)
Px1 X 1 > PX 2 X 2

X 1 PX 2
< − Cost of producing given output can be reduced
X 2 PX 1 by increasing X1 and reducing X2 (LCC)
Px1 X 1 < PX 2 X 2

4. CACP- Cost concepts

i) Cost of Production and Cost of Cultivation: Cost of production is referred to the
expenses incurred per unit of output whereas cost of cultivation is referred to the
expenditure incurred per unit area of crop cultivated. Cos t of production for major
crops is often discussed for government’s policy formulation in price fixation.
Moreover, farmers often lodge complaints on the ground that the price does not cover
the cost of production. Hence, the need to study the cost compone nts and cost of
production of various crops is evident. Better understanding of various cost
components would be useful to control and mana ge different cultivation practices.
ii) Cost Concepts: Some of the cost concepts used in farm management studies by the
Commission on Agricultural Costs and Prices (CACP) of Government of India are A1, A2, B1, B2, C1
and C2, which are defined as follows

Cost A 1 includes:
1. Value of human labour (casual and permanent).
2. Value of bullock power (owned and hired).
3. Value of machine power (owned and hired).
4. Value of seeds.
5. Value of manures and fertilizers.
6. Value of plant protection chemicals.
7. Value of weedicides.
8. Irrigation charges.
9. Land revenue and other taxes.
10. Depreciation on farm implement and fa rm buildings.
11. Interest on working capital.
12. Other miscellaneous expenses.
 The following concepts can be used for easy calculation of the cost of cultivation.
1) Depreciation for buildings: 2 per cent for pucca building; 5 per cent for tiled
building and 10 per cent for katcha building.
2) Depreciation for implements: 10 per cent for major implements and 20 per
cent for minor implements.
3) Depreciation for cattle: Appreciation in the value of animals during the first 3
years would be at the ratio of 1:3:5.It remains constant during 4 th and 5 th year. Then
it is assumed that the value of animal depreciates @ 12.5 per cent per year from 6t h to
14 th year in straight-line method.
4) Interest on working capital: 12 per cent per annum or opportunity cost of
capital.
Cost A 2 = Cost A 1 + Rent paid for leased in land.
Cost B 1 = Cost A 1 + Interest on the value of owned capital assets (excluding lan d).
Interest rate of long - term government floated loans or securities: 10 per cent.
Cost B 2 = Cost B 1 + Rental value of owned land (less land revenue) and Rent paid for
leased in land.
Cost C 1 = Cost B 1 + Imputed value of family labour.
Cost C 2 = Cost B 2 + Imputed value of family labour.
iii) Income measures in relation to different cost concepts
1. Farm Business Income = Gross Return - Cost A 1.
2. Owned Farm Business Income = Gross Return - Cost A 2.
3. Family Labour Income = Gross Return - Cost B 2.
4. Net Income = Gross Return - Cost C 2.
5. Farm Investment Income = Net Income + Imputed rental value of owned land +
Interest on fixed capital.
 Lecture No. 6.
Economies of Scale – Economies of Size – Determination of Optimum Input and Output-
Physical and Economic Optimum
1. ECONOMIES OF SIZE

All inputs are variable in the long run. Production Planning in the long run consists of
evaluating all production possibilities the farmer could take up. All durable inputs put together is
known as plant. In farming, durable inputs such as land, buildings, machineries, and animals
constitute a plant. The size of the plant decides the maximum production capacity of the farm. An
increase in one or more durable inputs increases the plant size and consequently the production
capacity. To make the analysis simple let us consider two inputs viz., X1, available labour and X2,
the plant size. For each plant size (output level) there will be a corresponding level of variable input
that minimizes the cost of producing a given output level. The average cost of production at
different level of output (Plant size) decreases up to certain level and beyond that it starts
increasing. Economies of size is realized as long as the long run average cost declines in response
to increases in plant size. The optimum plant size (output) is one which results in minimum
long run average cost. Diseconomies on size occur when it is rising. Thus, economies of scale
refer to the advantages of large-scale production. Increase in plant size improves efficiency due to
specialization of labour, mechanization, purchase of inputs at discount, etc. But beyond certain
level the long run average cost rises due to difficulties in management and control.

Fig 3.3 Economies of size

Economies of size
In farming as the size of a farm increases, cost per unit of production decreases, increased
efficiency resulting from large size. (Eg.). The cost of production per kg of paddy in case of a 10 ha
farm will be lesser than that of a per kg of Paddy produced from a 5 ha farm. This is because a 10
ha farm can effectively utilize labour and get other inputs at cheaper cost comparatively than that of
a 5 ha farm. There are two types of economies a) internal economies and b) external
economies.
a) Internal Economies
Internal economies are those economies in production, those reductions in production costs,
which accrue to the farm itself when it expands its output or enlarges its scale of production. This is
due to use of methods which small farms do not find it worthwhile to employ.
Internal economies may be of the following types
(i) Technical Economies (ii) Managerial Economies (iii) Commercial marketing Economies (iv)
Financial Economies and (v) Risk bearing Economies.
i. Technical Economies
It refers to the size of factory or establishment. It prevents wastage by utilizing the by-
products efficiently. Latest technologies can be used in larger units to reduce the cost of production.
It arises from use of (i) Large size machineries (ii) Linking process- integration of two or more is
more economical. Eg. dairy farm + fodder farm, Sugar factory + Sugarcane farm, paper making &
pulp making. (iii) Superior technique – Large establishments can have power driven machinery.
(iv) Increased specialization – Specialization and division of labour are highly advantageous.
ii. Managerial Economies
These economies arise from the creation of special departments or from functional
specialization for different functions like production, maintenance, purchase, sales etc.. There is a
vertical division of labour starting from workers to manager. Thus, the job can be done more
efficiently and more economically in large units.
In general concentrate on the jobs which bring more profits. In large farms manager collects
new technologies. For managing routine works, a permanent labour is employed and to perform
various operations workers are employed.
iii. Commercial Economies
These arise from purchase of materials and sale of goods. Large farms have better
bargaining power. Credit institutions will give special attention. Selling cost will be less and the
profit will be more. A large firm can employ expert purchase managers and sales managers. In
selling, it can cut down selling costs and in purchasing, it can have a wider choice.
iv. Financial Economies
Large farmers have better credit and can borrow on more favourable terms which lead to
more investment and more income. A big firm can issue its shares and debentures more easily than
an unknown small firm.
v. Risk Bearing Economies
Large farmers can spread risk and avoid risk/eliminate them by diversifying the output.
b) External Economies
External economies are those economies, which accrue to each member firm as a result of
the expansion of the industry as a whole. Expansion of industry may lead to the availability of new
and cheaper raw materials, machineries and to the use of superior technical knowledge. External
economies are advantages available to all the firms. For instance, construction of a new railway line
benefits all firms set up in that locality and not to any particular firm alone. Various types of
external economies are given below:
i. Economies of concentration
These arise due to availability of skilled labour, better transport and credit facilities. Every
firm in the industry shared the common stock of knowledge and experience.
ii. Economies of Information
These economies refer to the benefits which all firms engaged in an industry derive from the
publication of trade and technical journals and from central research institutions, which would
benefit all firms.
iii. Economies of Disintegration
When an industry grows it becomes possible to split up some of the processes which are
taken over by specialist firms. Examples are spare parts manufacturing units/assembling units.
Diseconomies of size
It is opposite to Economies of Size. It is a proven fact as the size of farm expands, the unit
cost comes down. However, expansion beyond certain point results in increased unit cost of
production owing to managerial problem and other factors which is termed as “Diseconomies”.
Increase in production (or) large scale production may lead to increase in cost due to
following reasons.

i) Over-worked Management: A large – scale producer cannot pay full attention to every detail.
Cost often rises due to the dishonesty of the employees or waste of materials by them. This is due to
lack of supervision.

ii) Individual tastes: If the consumers are not satisfied because large scale production is meant for
mass. This leads to loss of customers.

iii) No personal Element: Large scale firms are managed by paid employees. Due to lack of
personal touch between the owner and employers there may be frequent misunderstanding. Which
lead to strikes and lock- outs. This is harmful to the business.

iv) Possibility of depression: Large scale production leads to over production. Production is more
than the demand. It is not easy to dispose a large quantity in a profitable manner.

v) Lack of adaptability

Large farms find difficulty in switch over from one enterprise to another enterprise. If there
are more number of farms it leads to competition for labour, raw materials which in turn increases
higher cost, wages and cost of operation and hence less profit. Sometimes, due to scarcity farms use
inferior or less efficient factors which also lead to increase in cost.

Methods of Determining the Optimum Level

The problem here is to determine the most profitable point of operation for an
enterprise in the short-run. This can be done by determining either the most profit able
amount of input or the most profitable level of output. As the production function
relates the input to output in a unique manner in stage II, either method results
ultimately the same answer. In economic terminology, the “most profitable” amount
can be called the “optimum” amount.
a) Determining the Optimum using Total Value Product and Total Costs: Total
Value Product, TVP, is the total value of the production of an ent erprise. TVP = Py.
Y, where Py is the price per unit of the output and Y is the amount of output at any
level of input X. Total value product minus total cost is the profit which is also cal led
net returns or net revenue. As output increases, profit incr eases and reach a maximum
of Rs.30 at 8 units of input and 28 units of output as could be seen from the table
10.4. Maximum profit from an enterprise does not necessarily occur where output i s at
its maximum. Output reaches a maximum of 29 units at 9 unit s of input. Therefore,
the point of maximum yield is not necessarily the same a s the point of maximum
profit.
Profit = TVP – TC = TVP –TVC – TFC = Py.Y – Px X – TFC.
b) Determining the Optimum Amount of Input
The criterion for determining the optimum amo unt of input is derived from the
slopes of total value product and total cost cu rves, when those curves are plotted as
functions of the input, X. First, consider the profit equation as the fu nction of input.
Profit = Py. f(X) – Px X – TFC, where, Y = f(X).
In order to maximize this function with respect to the variable input, the fir st
derivative is set to zero as follows:
dProfit dY
= Py − Px = 0
dX dX
Py.MPP-Px=0
Py.MPP=Px, ie., VMP-Px
But, the term Py. MPP is the slope of TVP curve and is called the Value o f Marginal
Product (VMP). The term Px is the slope of the total cost function. I n pure
competition, Px will always be constant. Dividing both sides of Py, we get,
Px
MPP = So, another method of stating the marginal criterion is to say that
Py
the marginal product of vari able input must equal the inverse ratio of prices (input -
output price ratio).
c) Determining the Optimum Amount of Output
The marginal conditions for the maximization of profit as a function of output can
be derived from the following profit function:
Profit = TR – TC = Py.Y – Px. X – TFC =Py.Y – Px.f -1 (Y) – TFC
where, the concept of the inverse production function must be used to express X
as a function of Y. That is, X = f -1 (Y) in stages I and II. Taking the derivatives of
profit with respect to Y results in:
dProfit dX
= Py − Px =0
dY dY
Px
=Py − =0
MPP
Px
Py = MC since MC=
MPP
Therefore, Py = MC at the optimum output level. Differentiation of profit equation with respect to
Y would give
d dTR dTC
= − =0
dY dY dY
dTR dTC
=
dY dY
i.c., MR = MC
where, the change in TR with respect to Y is defined as Marginal Reve nue, MR, while
the change in TC with respect to Y is the Marginal Cost, MC. In pure competition Py
= MR.
d) Comparison of Input and Output Criteria: All methods of determining the most
profitable level of output or input lead to comparable answers. The inp ut criterion
Y
VMP = Px can be written as Py. MPP = Px (or) Py = Px i.e., PyY = PxX
X
The expression, Py.Y measures returns added by an increase in output while Px. X
measures the cost added by the increase in input. But from the output
criterion, Py = MC, the same added cost and added return can be
Px X
derived. Py = MC = = Px
MPP Y
PyY = PxX
Thus, the two methods of determining the optimum levels are comparable.
TR
TVP
TC
TC

X
0 0 Y
TC

PROFIT PROFIT
0 TR

X MC
Py ATC

AVC
Px

VMP AFC
0 X 0
Y

Fig.10.8 (a) Determining the Optimum Fig. 10.8 (b) Determining the
Amounts of Input Using Total Value Optimum Amount of Output
Product, Total Cost, Profit and Value Using Cost and Revenue
of Marginal Product Curves. Curves.
Input Total Averag Margin Total Total Total Averag Averag Averag Margin Margina
(unit) output e al Fixed Variab cost e Fixed e e Total al cost l
(Unit) Produc produc Cost le Cost TFC+T cost variabl cost (MC) Revenue
t Y TFC(R (TVC) VC (AFC)= e cost (ATC) TC (MR)
t= =
Y/X X s) @ Rs (Rs) TFC/Y (AVC) =TC/Y Y TR
=
(unit) (units 2/unit TVC/Y Y
0 0 0 0 10 0 10 0 0 0 - -
1 2 2.00 2 10 2 12 5.00 1.00 6.00 1.00 2
2 5 2.50 3 10 4 14 2.00 0.80 2.80 0.67 2
3 9 3.00 4 10 6 16 1.11 0.67 1.78 0.50 2
4 14 3.50 5 10 8 18 0.71 0.57 1.28 0.40 2
5 19 3.80 5 10 10 20 0.53 0.53 1.06 0.40 2
6 23 3.83 4 10 12 22 0.43 0.52 0.95 0.50 2
7 26 3.71 3 10 14 24 0.38 0.54 0.92 0.67 2
8 28 3.50 2 10 16 26 0.36 0.57 0.93 1.00 2
9 29 3.22 1 10 18 28 0.34 0.62 0.96 2.00 2
10 29 2.90 0 10 20 30 0.34 0.69 1.03 - 2
11 28 2.55 -1 10 22 32 0.36 0.79 1.15 - 2
12 26 2.17 -2 10 24 34 0.38 0.92 1.30 - 2
 Lecture No. 7.
Factor – Factor Relationship: Least Cost Combination of inputs
In factor-product relationship, we studied the situation where only one input is
varied and all other variables are held constant. But in most real-world situations,
two or more inputs are often varied simultaneously. So a farmer must choose the
particular combination of inputs which would minimize the cost for a given output
level. Thus, the main objective here is minimization of cost at a given level of output.
When two or more inputs are variables, a given amount of output may be produced in
more than one way, i.e., there is a possibility of substituting one factor (X 1 ) for
another (X 2 ) as product level (Y) is held constant. The objectives of facto r-factor
relationship are i) minimization of cost at a given level of output and ii) optimization
of output to the fixed factors through alternative resource -use combinations. In this
case, the production function is given by Y = (X 1 , X 2 / X 3 ,..., Xn), i.e., the production
depends on the amounts of X 1 and X 2 while the other inputs are held constant.
A. ISOQUANT (OR) ISO PRODUCT CURVE
An isoquant is defined as the locus of all combinations of inputs, X 1 and X 2, for
obtaining a given level of output, say, Y (0) . Mathematically, such an isoquant is
written as: X 1 = f (X 2 , Y (0) ) or X 2 = f (X 1 , Y (0) ). Some of the important types of
isoquants depending upon the degree of substitutability between the inputs, are given
in figures below:
i) Linear Isoquant: In this case, two inputs substitute at constant rates. Labour input
supplied by different persons substitutes at a constant rate. Ammonium sulphate
containing 20.6 per cent nitrogen and urea containing 46 per cent nitrogen would
substitute for each other at a con stant rate. The decision rule is simple, i.e., use either
of the two factors of production depending on their relative prices. The rate at which
one factor (X1) is substituted for one unit increase in another factor (X2) at a given
level of output is called Marginal Rate of Substitution (MRS). The marginal rate of
substitution of X2 for X1 is denoted by:
X 1
MRSX2X1= In linear isoquant, the rate at which these two inputs can be substituted at a given
X 2
level of output is constant regardless of the level of the two inputs used.
X 11 X 1 X 12 X 1n
MRSX2X1= = = =….=
X 21 X 2 X 22 X 2 n
 X1 X1

. (0)
(0)
X1 = f (X2, Y )
. X1 = f (X2, Y )

.
X2
X2
Fig.101 Linear Isoquant Fig.10.2 Inputs Combine in Fixed Proportion

ii) Fixed Proportion Combination of Inputs (Perfect Complemen ts): Inputs that
increase output only when combined in fixed proportions are called technical
complements. Only one exact combination of inputs will produce the specified output.
A tractor and a driver may serve as a fairly good example. Here, there is no economic
problem in decision-making because there exists no alternative choice.
iii) Varying (Decreasing) Rate of Substitution: The amount of one input (X1)
required to be substituted for by one unit of another input (X2) at a given level of
production decreases. This is known as decreasing rate of substitution. Thus,
decreasing rate of substitution means that every subsequent increase in the use of one
X 11 X 12 X 1n
factor replaces less and less of the other. MRSx2 x1 =   .... 
X 21 X 22 X 2 n

Each point on the isoquant is the maximum output that can be achieved with the
corresponding input combination. Isoquants are co nvex to the origin Fig.10.3. Two
isoquants do not intersect each other.
iv) High contours represent higher output levels: Isoquant map indicates the shape
of the production surface, which again indicates the nature of output response to the
inputs. An isoquant which is far away from the origin represents higher level of output
than an isoquant which is closer to the origin.
v) Marginal Rate of Input (Factor) substitutions (or) Rate of Technical
Substitution (RTS): Marginal Rate of Substitution of X 2 for X 1 (MRS X2X1 ) is defined
as the amount by which X 1 must be decreased to maintain output at a constant
level when X 2 is increased by one unit. Between the two points (X 2 =2, X 1 =10) and
X 1 5 − 10 −5
X 2 =3, X 1 = 5), the MRS of X 2 for X 1 is MRSx2 x1 = = = = −5 .
X 2 3 − 2 1
The MRS is negative, because the isoquant slopes down ward and to the right; that is,
the isoquant has a negative slope.
Table Decreasing Rate of Substitution
X 1 X 2 X 1
Variable Variable MRSx2 x1 =
input(X1) input (X2) X 2

23 0 - - -
16 1 7 1 -7
10 2 6 1 -6
5 3 5 1 -5
1 4 4 1 -4
0 5 1 1 -1
vi) Isocost line:Isocost line determines all combinations of the two inputs that cost
the same amount. Each point on the isocost line represents a combination of inputs
that can be purchased with the same outlay of funds (Fig.10.4). Under constant price
situation, each possible total outlay has a different isocost lin e. As total outlay
increases, isocost line moves higher and higher and moves farther away from the
origin. Changes in the input prices will change the slope of isocost line as the slope
indicates the ratio of input prices. A decrease in the input price means that more of
that input can be purchased with the same total variable cost; an increase m eans that
less can be purchased.
Total Outlay = Rs.36; Price of X1 = Rs. 4; Price of X2 = Rs.3; When X1 = 0, X2 = 12; When X2 = 0,
X1 = 9

X1

X1 = f (X2, Y (0)) X1 Isocost Line

X2

X2
Fig.10.3 Convex Isoquant. Fig.10.4 Isocost Line

The equation of the isocost line can be found by solving the TVC equation for X 1
TVC Px2
as an explicit function of X 2 .Px 1 X 1 = TVC – Px 2 X 2 and X 1 = − X 2 . From this
Px1 Px1
expression, it can be seen that the slope of isocost line is – Px 2 / Px 1 while the
intercept on X 1 is TVC / Px 1.
vii) Least cost combination: The problem here is to find out a combination o f inputs,
which should cost the least, i.e., minimization of cost. The tangency of isocost and
isoquant would indicate the least cost combination of X 1 and X 2 , i.e., slope of
isoquant = slope of isocost. Least cost combination is given, algebraically, by
X 1 Px
equating MRSx2 x1 = = − 2 i.e., -Px1X 1 = Px 2 X 2
X 2 Px1
If - Px 1 (X 1 ) > Px 2 (X 2 ), then, the cost
of producing the given output amount
could be reduced by increasing X 2 and
Isoquant
decreasing X 1 because the cost of an
Iso Cost Line
added unit of X 2 is less than the cost of
Least Cost the units of X 1 , it replaces. On the other
Combination
hand, if between two points of the
isoquant,Px 1 (X 1 ) < - Px 2 (X 2 ), then
the cost of producing the specified
Fig.10.5 Least Cost Combination quantity of output can be reduced by
using less X 2 and adding X 1
The marginal physical product equations can be used to determine the returns per rupee spent at the
least cost point. Rewriting the least cost combination as
Y = f ( X1, X 2 )
MPPX 1 MPPX 2
= total differential is;
Px1 Px2
Y Y
X 1 dX 1 MPPX 2 Px2 dY= dX 1 + dX = 0
− = = =  X1  X2 2
X 2 dX 2 MPPX 1 Px1
Y
dX  X2 MPPX 2
− 1 = MRSorRTS = =−
dX 2 Y MPPX 1
 X1
viii) Isoclines, Expansion Path and Profit Maximization: Isoclines are lines or curves that pass
through points of equal marginal rates of substitution on an isoquant map. That is, a particular
isocline will pass through all isoquants at points where the isoquants have a specified slope. There
are as many different isoclines as there are different slopes or marginal rates of substitution on an
isoquant. The expansion path is also an isocline that connects the least cost combinations of inputs
for all yield levels. On expansion path, the marginal rate of substitution must equal the input price
ratio:
X 1 Px
Expansion Path (MRS X2X1)= =− 2
X 2 Px1

Ridge lines represent the limits of the economic relevance, the boundaries beyond
which the isocline and isoquant maps have no economic meaning. The horizontal
ridge line represents the points where M PPx 1 is zero and the vertical line represents
the points where MPPx 2 is zero.
On the ridge line for X1, MPPX1 is zero, and tangent to the isoquant which is vertical having
no defined slope. On the ridge line for X2, MPP X2 is zero and the soquant has a zero slope and thus
MRS=0, Ridge lines are so named.

X 2 MPPX 1 0
Ridge line for X1= = 0, = =0
X 1 MPPX 2 MPPX 2
X1
9 Irrational X 1 Px
Expansion path= =− 2
Zone X 2 Px1
Y=130
Isoclines
Y=120
Irrational Zone
RATI
ONA Y=108 Ridge line for
L X 1 MPPx2 0
ZONE X2= = 0; = − = =0
Y=100 X 2 MPPx1 MPPx1
X2

Y= 45

MPPx2
The slope of the isoquant was shown to be: MRSx2 x1 =
MPPx1
the isoquant has a zero slope and thus MRS = 0. Ridge lines are so named
because they trace the high points up the side of the production surface, much like
mountain ridges that rise to the peak of the mountai n. Ridge lines represent the points
of maximum output from each input, given a fixed amount of the other input. When X 1
= 1, output can be increased by adding X 2 up to the amount devoted by the ridge line
(7 units). At that point, output from X 2 is a maximum given one unit of X 1 and MPP
X2 is zero. Past X 2 = 7, MPP X2 is negative while MPP X 1 is positive; the inputs have

an opposite effect on output and are no l onger substitutes. Thus, the ridge lines denote
the limits of substitution. Outsidethe ridge li nes, the inputs do not substitute in an
economically meaningful way. Output is maximum (1 40) where the ridge lines, and
all other isoclines, converge. For 140 u nits of output, the least cost and only possible
combination is 9 units of X 1 and 7 units of X 2.
ix) Expansion Path and Profit Maximization
The expansion path traces out the least cost combination of inputs for every
possible output level. The question no w arises; which output level is the most
profitable? Conceptually, this question is answered b y proceeding out the expansion
path that is increasing output until the value of the produ ct added by increasing the
two inputs along the expansion path is equal to the combined cost of the added amount
of two inputs. Viewed from the input side, this is sa me as saying that the VMP of each
input must equal the unit price of that input; viewed fr om the output side, it is the
same as saying the marginal cost must equ al marginal revenue. Thus, while all points
on an expansion path represent least cost combinat ions, only one point represents the
maximum output level. For one output and two variable inputs, the equation is:
Profit = Py Y - Px 1 X 1 - Px 2 X 2 – TFC.
Maximizing this function with respect to the variable inputs gives two equations in two unknowns
 Pr ofit Y
=Py − Px1 = 0;
 X1  X1
The above two equations can be written as: VMPx 1 = Px 1
 Pr ofit Y
=Py − Px2 = 0;
Y  X2
(or)VMPx 2 = Px 2. Thus, the profit-maximizing criterion requires that the marginal
earnings of each input must be equal to its cost. Y = 18X 1 - X 1 2 + 14X 2 - X 2 2

The marginal physical products of X 1 and X 2 are multiplied by Py = Rs. 0.65.

Then, VMPx 1 = (18 - 2X 1 ) 0.65; VMPx 2 = (14 - 2X 2 ) 0.65. Equating VMP’s with the
input prices of Rs.9 and Rs.7 for X 1 and X 2 respectively, we get, (18 – 2X 1 ) 0.65 = 9;
(14 – 2X 2 ) 0.65 = 7
The solutions are 2.08 for X 1 and 1.6 for X 2 . Substituting these values in the
production function predicts a value of Y equal to 53 units.
Then, Profit = 0.65 (53) - 9 (2.08) - 7 (1.60) - TFC= Rs. 4.53 - TFC
The optimum criterion for two variable inputs is often expressed as:
VMPx1 VMPx2 VMPx1 VMPx2
= 1; = 1; or because both equal 1, = = 1;
Px1 Px2 Px1 Px2
All variable inputs must be earning as much as they cost on the margin. Rewriting in a different
Px MPPx1 1 1
form, yields; MPPx1 = 1 ; = = since Py=MC
Py Px1 Py MC
Px MPPx2 1 1
MPPx2 = 2 ; = = since Py=MC
Py Px2 Py MC
The above expression is the same as MR = MC under perfect competition.
 Lecture No. 8.
Product – Product relationship: Optimum Combination of Products – Principle of Equi-
marginal Returns – Principle of Opportunity cost and Minimum loss principle. Law of
Comparative Advantage
In this section, instead of considering the allocation of inputs to an enterprise or
among enterprises, we discuss enterprise combi nations or product- mix involving
product-product relationships. We deal with what combination o f enterprises should
be produced from a given level of fixed and variable inputs.
A. PRODUCTION POSSIBILITY CURVE (ISO -RESOURCE CURVE)
The production possibilit y curve or product transformation curve is the locus of
maximum amounts of two products, say Y 1 and Y 2 , that can be produced from a given
quantity of resources (X (0) ). Mathematically, such product transformation curve is
represented by: Y 1 = f (Y 2 , X (0) ) or Y 2 = f ( Y 1 , X (0) ). The Rate of Product
Transformation (RPT) (or) Marginal Rate Product Subs titution (MRPS) between two
products, Y 1 and Y 2, is given by the negative slope of this curve. The RPT of Y 2 for
Y 1 can either be expressed as:
dY Y
− 1 (Point concept) or - − 1 (Average or arc concept)
dY2 Y2
dY 1 / dY 2 , the slope of the product transformation curve can be defined as the change
(increase or decrease ) in the level of Y 1 that must be accompanied by a unit change
(decrease or increase ) in the product (Y 2 ) at a given level of resource.
i) Relationship among Products: The basic product relationships can be: joint,
complementary, supplementary and competitiveness.
a) Joint Products: Products, which result from the same production process, are
termed joint products. In the extreme case, two products are combined in fixed
proportions and the production of one without the other is impossible. E.g. Grain and
straw. Production possibility curves for joint products of this type are presented in
Figure 12.1 (a). No substitution is possible in this case. However, for example,
different varieties of paddy produce varying proportions of straw and grain. T hus, the
proportions may be changed by technologies or cropping practices usually associated
with the fixed inputs. For such products, a narrow range of product substitution may
exist as presented in Figure12.1 (b).
 Y Y
1 1

C
B
A

Y Y
0 Fig. 12.1 (a) Joint 2 0 Fig. 12.1 (b) Joint 2
Products Products
b) Competitive Products: Products are termed competitive when the output of
one product can be increased only by reducing the output of the other product.
Outputs are competitive because they require the same inputs at the same time.
E.g. the manager can expand production of one output only by diverting
inputs-land, labour, capital and management -from one enterprise to another.
Y1
 0 When the production possibility curve ha s a negative slope, the
Y2
products concerned are competitiv e. Two competitive products can substitute
each other either at a constant or increasing or decreasing rate. Substitution of
one product for another product at a constant rate is only a short -run
phenomenon because such a relationship may not hold for long . Two varieties
of any crop with all inputs held constant, during any single season provide an
example of this type of substitution. Economic decision-making is easy in this
case, i.e., the farmer would produce only one of these products depending upon
yields and prices. Whenever a decreasing RPT exists between two products,
every unit addition of one produ ct, say Y 2 replaces less and less of other
product, Y 1 .The product transformation curve is conca ve away from origin and
convex toward the origin. This type of relationship is quite rare. This type of
decreasing RPT can be found in very small farms where ca pital is very limited
and the produce of none of the two competitive commodities can be extended
beyond the first stage of production. Decision-making is simple in this case,
i.e., the farmer would produce only one of the two products depending on
relative yields and prices. An increasing rate of product transformation
between two products occurs when both products are produced i n the stage of
decreasing returns. The product transformation curve is concave towards the
origin, i.e., increasing amounts of Y 1 must be sacrificed for each successive
gain of one unit of other product, Y 2 for a given level of input.

Y
Y11

1 Y21
Y12
Y22
Y
1 Y11

Y Y21
Y12

0 Fig. 12.2 Y Y11

Y21 Y12
Y22

1 Y22

2
(a)
Y
Decreasin Y 0 Fig. 12.2 (c)
2
g RPT 0 Fig. 12.2 (b) 2 Constant
Increasing RPT
Y2Y1 Y 2Y 1 RPT Y2Y1
c) Complementary Products: Two products are complementary, if an increase
in one product causes an increase in the second product, when the total amount
of inputs used on the two are held constant.

In the figure 12.3(a), Y 2 is complementary with Y 1 until the point A is

reached. To the right of A, both are competitive. Thus, if the farmer wishes to
produce the maximum possible amount of Y 1 , he should grow at least OB
amount of Y 2 . When larger quantities of Y 2 are produced, the two products
become competitive. In Fig.12.3 (b), there is a situation where each output is
complementary to the other output over a certain range. Thus, Y 2 is
complementary to Y 1 , up to C, and Y 1 is complementary to Y 2 up to D. The
two products become competitive between C and D.
Complementary usually occurs when one of the products produces an input
used by the other product. An example of this is the use of a legume in rotation
with cash crop. The legume may add nitrogen and improve so il structure or
tilth and improve weed and insect control. These factors, in turn, serve a s
“inputs” for cash crops thus causing, over a period of time required by the
rotation, an increase in the production of cash crop. The complementary
products may eventually become competitive. For example, while one year of
alfalfa in a four-year rotation may be complementary, two, three or four years
of alfalfa could be produced only by successive reductions in the cash crops.
Y
MRPS = of Y2 for Y1 = 1
Y2
d) Supplementary Products: Two products are called supplementary, if the
amount of one can be increased without increasing or decreasing the amount of
the other. In figure 12.4 (a) Y 2 is supplementary to Y 1 . Y 2 can be increased
from zero to OH amount without affecting the amount of Y 1 produced. Beyond
E, the two outputs become competitive. In Fig.12.4 (b), each enterprise is
supplementary to the other and competitive between FG. Supplementary
enterprises arise through time or when surplus resources are available at a
given point of time

. Once purchased, a tractor is available for use throughout the year. Its use in
one month does not prevent its use in another month. Thus, a tractor purchased
to plough and plant may be put to a lesser use during the off-season. If two
crops were harvested at the same time, however, the relationship would be
competitive-use on one could reduce the amount of use on the other.
The supplementary relationship between products depends upon amou nt of
use left in the resource. If the harvester is completely worn out harvesting corn
in June, it will not be available for use in July. Milk cows and family gardens
represent supplementary enterprises on some farms. In each case, labour or
some other input is available for use on a small scale and rather than let it go
Y
idle, a small enterprise is undertaken. MRPS of Y2 for Y1 = 1 = 0 Production
Y2
possibility curve is also known as opportunity curve as it presents all possible
production opportunities.
ii) Marginal Rate of Product Substitution or Rate of Product Transformation: RPT is
nothing but the slope of production possibility or opportunity curve.
Y
MRPS of Y2 for Y1 = 1
Y2
The marginal rate of product substitution means the rate of change in
quantity of one output (Y 1 ) as a result of unit increase in the other output (Y 2 ),
given that the amount of the input used remains constant. As th e amount of Y 2
produced increases, the amount of Y 1 sacrificed steadily increases. This is due
to the decreasing marginal physical products displayed by the production
functions.
iii) Iso Revenue Line: It is the line which defines all possible combinations of two
commodities which would yield an equal revenue or income. Iso revenue line
indicates the ratio of prices for two competing products. The point on Y2 axis is
always equal to TR/PY2 while the point on the Y1 axis equal TR/PY1. The distance of
the Iso revenue line from the origin is determined by the magnitude of the total
revenue. As total revenue increases, the iso revenue line moves away from the origin.
The slope of the iso revenue line is determined by the output prices.

TR = Py1Y1 + Py2Y2
Y
TR  Py2 
Change

Y1 = −  Y2
in Py1

1 Py1  Py1 
Rise
Slope of Iso Revenue line=
Run
TR TR
0−
Py1 Py Py
=− 1 =− 2
TR TR Py1
−0
Py2 Py2
Y
0 Change
Fig. 12.5 Iso
in Py1 2

Revenue line
 Thus, the output prices ratio is the slope of the iso revenue line. The negative
sign means that the iso revenue line slopes downward to the right. The iso revenue
lines are used for revenue optimization, while iso cost lines are used for cost
minimization.
iv) Revenue Maximizing Combination of Outputs
The maximum revenue combination of outputs on the production possibility
curve can be determined using the criterion

Y2 Py
MRPSY1Y2 = =− 1
Y1 Py2
This can be rewritten as follows: Py 1 (Y 1 ) = - Py 2 (Y 2 ). This criterion states that
at the maximum revenue point, the increase in revenue due to adding a minute
quantity of Y 2 is exactly equal to the decrease in revenue caused by the reduction in
Y 1 . Thus, there is no incentive to change the output comb ination. When Py 1 (Y 1 ) >
- Py2 (Y 2 ), the amount of Y 2 should be decreased in favour of Y 1 . When Py 1 (Y 1 )
< - Py 2 (Y 2) , then Y 2 should be increased at the expense of Y 1 . As could be seen in
the Figure 12.7, the line connecting maximum revenue points is called output
expansion path. For each level of input, the maximum revenue combination of
outputs will fall on the expansion path

61
 Y2
Production possibility curve

Y2 Py
MRPS Y1Y2 = =− 1
Y1 Py2

Iso Revenue Line

Y1
0 Fig. 12.6 Maximum Revenue Yielding Combination

v) Opportunity cost and Marginal criterion for Resource Allocation:

Maximum revenue from a limited amount of input was shown to occur when
Y2 Py
= − 1 and this could be written as follow Py 1 (Y 1 ) = - Py 2 (Y 2 ), where Y 1
Y1 Py2
is negative.

But the decrease in Y 1 could only be caused by shifting some amount of input, X,
from enterprise (Y 1 ) to enterprise Y 2 . Denote the amount of input shifted by ‘X’.
Dividing both sides of the above expression by X and multiplying both sides of
the equality by minus one gives.

Y2 Y
Py2 = Py1 1
X X
Py2 .MPPxy2 = Py1.MPPxy1
VMPxy2 = VMPxy1

62
 Thus, revenue from the limited amount of input, X, will be a maximum when the
value of the marginal product of the input is the same in each enterp rise. (The
notation, MPP xy 1 and VMP xy2 , is used to denote the MPP of X on Y 1 and VMP of

X used on Y 2 respectively). Equating the VMP’s of the input in the two enterprises
leads to the identical solution obtained from the production possibility curve. The
two criteria are compared in Table 12.1 (a) and 12.1 (b) below:

Y
2

8
6.
0 Production
74.
possibility curve
5
9
7 48.
4 5 Output
3 expansion path
2
5.
3 2 7
0 Iso
1.
1
Revenue
5
7.
9 Line
5
.
0

9 15. 21. 2
Y
0 Fig. 12.7. Output
. Expansion
5 5 Path
5. 1
0 5

Table 12.(a) Comparing the Marginal criteria for Resource Allocatio n and
Production possibility curve
Variable Outp MPP XY VMP XY1 Variable Outp MPP XY VMP XY2
Input ut 1 @Py 1 = Input ut 2 @Py 2 =
(X) (Y 1 ) Re.1/unit (X) (Y 2 ) Rs.2/unit
0 0 - - 0 0 - -
1 12 12 12 1 7 7 14

63
2 22 10 10 2 13 6 12
3 30 8 8 3 18 5 10
4 36 6 6 4 22 4 8
5 40 4 4 5 25 3 6
6 42 2 2 6 27 2 4
7 43 1 1 7 28 1 2

For two units of input, one to Y1 where it would earn Rs.12 and the second to Y2 for an earning
of Rs.14, the total revenue would be Rs.26. The second unit could also go to Y2 and the earning
would be unchanged. From the production possibility curve for 2 units of input, in Fig.12.7,
maximum revenue combination

Table 12.1(b) Comparing the Marginal Criteria for Resource Allocation and
Production Possibility Curve
Units of Solution Equating VMP Solution using Production
Inputs Possibility Curve
Available Y2 Y1 TR Y2 Y1 TR
2 7 12 26 9 9 27.0
4 13 22 48 15.5 17.5 48.5
7 22 30 74 21.5 31.5 74.5
9 25 36 86 25.5 35.0 86.0
Py1 = Re.1; Py 2 = Rs.2.
of outputs is 9 each of Y1 and Y2 and the total revenue is Rs.27 which is slightly more than the
allocation using “average” marginal criteria. The numbers 2, 4, 7 and 9 given the fig.12.7 are
input levels of production possibility curves. The numbers 27, 48.5, 74.5 and 86 are revenue
levels of iso revenue lines. Thus, the geometric approach is more accurate. This allocation of
inputs between products can also be viewed in terms of opportunity cost. It demonstrates the cost
in terms of the value of an alternative product that is given up rather than the purchase price of
variable input. As long as VMP in one enterprise, that is sacrificed, equals the VMP in the other
enterprise, that is gained, the opportunity costs for both enterprises are equal and total returns are
maximum

Equi - Marginal Principle

In input-output relationship, MC=MR is the economic principl e used to
determine the most profitable level of variable input. But it is under the assumption
of unlimited availability of variable input. Such an assumption of unlimited
resources is unrealistic. So, in real world situations, the equi -marginal principle is

64
 useful in determining how to allocate limited resources among two or more
alternatives. The principle says: If a scarce resource is to be distributed among two
or more uses, the highest total return is obtained when the marginal return per unit
of resource is equal in all alternative uses.
i) One Input - Several Products: Suppose, there is a limited amount of a variable
input to be allocated among several enterprises. For this, the production function
and product prices must be known for each enterp rise. Next, the VMP schedule
must be computed for each enterprise. Finally, using the opportunity cost principle,
units of input are allocated to each enterprise in such a way that the profit earned
by the input is a maximum. Profit from a limited amount of variable resource is
maximized when the resource is allocated among the enterprises in such a way that
the marginal earnings of the input are equal in all enterprises. It can be stated as:
VMPxy 1 = VMPxy 2 = .... = VMPxyn where, VMPxy 1 is the value of marginal
product of X used on product Y 1 ; VMPxy 2 is the value of marginal product of X
used on product Y 2 ; and so on.

VMP xy 1 = Py 1 MPPxy 1 ; VMPxy 2 = Py 2 MPPxy 2 and so on.

Table 12.2 Allocation of Limited Variable Input among Three Enterprises
Enterprise I (Maize) Y 1 Enterprise II (Sorghum) Y 2 Enterprise III (Ragi) Y 3
X Y1 VMP XY1 X Y2 VMP XY2 X Y3 VMP XY3
0 0 - 0 0 - 0 0 -
1 10 20 1 18 18 1 7 14
2 18 16 2 31 13 2 13 12
3 24 12 3 42 11 3 18 10
4 29 10 4 51 9 4 22 8
5 33 8 5 58 7 5 25 6
6 36 6 6 64 6 6 27 4
(Py 1 = Rs2; Py 2 = Rs 1; Py 3 = Rs 2)
Suppose that the farmer has five units of X. According to the opportunity cost
principle, he will allocate each successive unit of input to the use where its
marginal return, VMP, is the largest; i.e., first unit of X used in I earns Rs.20;
second on first unit of II earns Rs18; third on second unit of I earns Rs.16; fourth
on first unit of III earns Rs.14; and fifth on second unit of II earns Rs.13. Two
units of inputs go on I, two on II and one on III. Used in this manner, the five units
of inputs will earn Rs.81. No other allocation of the five units amo ng the three
enterprises will earn as much. What is the maximum amount of input needed for

65
enterprises I, II and III? To find out this, the manager must deter mine the most
profitable amount of input for each enterprise. When input cost is Rs.6.5 per unit ,
the optimum amounts are 5 for I, 5 for II and 4 for III. Cost is Rs.91 (5+5+4=14)
(6.5)=Rs 91. Thus, the manager would never use more than a total of 14 unit s of
inputs on I, II and III, no matter how many units of inputs he could afford to buy.

ii) Algebraic Example

Corn response to nitrogen production function is:C=65.54+1.084NC – 0.003N C 2 . .
.(1)
Sorghum response to nitrogen function is: S = 68.07+0.830N S – 0.002 N S 2 . . . . . .
(2)
Assume that the farmer has 100 kgs of nitrogen available for 2 acres - one acre
to be used for corn and one to be used for sorghum and that the price of corn is Rs.3
per kg and the price of grain sorghum is Rs2.50 per kg.
The allocate equations would be VMPNC =VMPNS (or) Pc MPPnc =Ps MPPns
dc
from (1) = 1.084 − 0.006 Nc and
dNc
dS
from (2) = 0.830 − 0.004 Ns
dNc
VMPNs = (0.830 − 0.004 Ns )(2.50) = Rs (2.075 − 0.01Ns )
SubstitutingNs = 100 − Nc, we get,
3.252-0.018Nc=2.075-0.01 (100-Nc)
2.177
Nc= = 77.8 and Ns=100-77.8=22.2
0.028
C=65.54+1.084Nc+0.003Nc2 =131.71668 x 3=Rs. 395.15
S = 68.07 + 083Ns − 0.002 Ns 2 = 85.51032 x 2.5=Rs.213.78

Thus, the corn would get 77.8 kgs of nitrogen and sorghum would get 22.2 kgs.
This allocation equates the value of marginal products and assures the largest return
from 100 kgs of nitrogen. Substituting 77.8 Kgs of nitrogen into VMPNc equation
and 22.2 Kgs into VMPNs equation, demonstrates that the VMP’s are equal to
Rs.1.85.
iii) Two inputs - Two outputs: Consider the case in which two inputs X1 and X2 can be used to
produce two products, Y1 and Y2. When the inputs are used in the first enterprise, the equi-
marginal principle dictates the following equality

Py1MPPX1Y1 Py1MPPX 2Y1 VMPX1Y1 VMPX 2Y1

= or =
Px1 Px2 Px1 Px2
Thus, the marginal earnings of each input must be the same per unit cost, even within a specific
66
enterprise. When both ratios equal one, the optimum has been reached. The same condition must
hold for the use of the two inputs in the second enterprise

VMPX 1Y1 VMPX 2Y1

=
Px1 Px2
Marginal returns per rupee spent on input must be same for both inputs in enterprises. Thus, the
general condition is:
VMPX1Y1 VMPX 2Y1 VMPX1Y2 VMPX 2Y2
= = =
Px1 Px2 Px1 Px2
Opportunity C ost
It is an economic concept closely related to the equi-marginal principle. Opportunity
cost recognizes the fact that every in put has an alternative use. Once an input is
committed to a particular use, it is no longer available for any other alternative use and the
income from the alternative must be foregone.
Definition : Opportunity cost is defined as the returns that are sacrificed from the next
best alternative. Opportunity cost is also known as real cost or alternate cost.
Minimum loss principle
There can be two decision situations: 1) when selling price covers the average total cost
and 2) when selling price is less than average total cost but more than average variable cost. In
short run, only variable costs are important in decision-making. In short-run, if price falls below
short-run average cost, the firm has no choice but to incur losses. The firm will shut down
production, if price falls below average variable cost. So the minimum of average variable cost
is the shutdown point.
Law of Comparative Advantage
The Law of Comparative Advantage states that an entity maximises its resources by
producing that which gives the best return, while delegating production of all other products and
services to other entities more cost-effective in their production”
Economic theory suggests that, if countries apply the principle of comparative advantage,
combined output will be increased in comparison with the output that would be produced if the
two countries tried to become self-sufficient and allocate resources towards production of both
goods. Taking this example, if countries A and B allocate resources evenly to both goods
combined output is: Cars = 15 + 15 = 30; Trucks = 12 + 3 = 15, therefore world output is 45 m
units.
While they produce based on its production advantage, Country B can produce 21 Truck
and Country A can product 30 Cars, thus total of 51 unit can be produced with their given
67
resources. Further by trading 3 trucks to country A for 15 cars, both A and B will be in the same
level of consumption. Country B now have the surplus of 6 Trucks over the demand or normal
consumption. Thus, comparative advantage with allowable trading besides achieving the self
sufficiency, the available resources are effectively allocated to produce more output to the
society.

Factors Determining change regional production pattern over time:

i) Changes in product or output prices.
ii) Changes in biological factors such as increased pest infestations.
iii) Introduction of new technology such as high yielding varieties, IPM, etc.
iv) Conversion of dry lands into irrigated lands.
v) Change in mode or cost of transportation, so as to decrease or increase the disadvantage

68
 associated with being distant from markets.
vi) Change in population that results in large, new consumption centres.
vii) Shifts in resources, such as labour and capital between regions.

69
 Lecture No. 10.
Farm Business Analysis: Meaning and Concept of Farm Income and Profitability,
technical and economic efficiency measures in crop and livestock enterprises
Farm business analysis

Farm business analysis is a name given to a technique based on computation and

interpretation of a variety of efficiency measures for the farm under the study. The results of the
analysis are then compared with standards derived from the groups of farms of similar size and
type. This comparison is used to highlight the organizational weaknesses and strengths of the
farm business.

Farm Efficiency Measures

An important element in farm business management or decision making relates to the manner in
which available resources are allocated vis-à-vis the objectives of the farmer.

A "measuring stick" is necessary to provide guides and standard for appraising accuracy of
decisions regarding the use of resources. One method of production is said to be more efficient
than the other when it yields a greater valuable output per unit of a valuable input. From an
economic stand point, efficiency is desirable and the science of farm management deals with
such principles and theories of farm business organization which are instrumental in increasing
the efficiency of the business.

Efficiency can be related to (1) the operation of the farm business as a whole, (2) any individual
phase of the business, line of production or enterprise (dairy, poultry, wheat, cotton, sugarcane,
maize, etc.).

Various efficiency measures, therefore, need to be developed to express technical efficiency in

various farm enterprises and to relate these to the financial success.

The various farm efficiency measures can be discussed as: (I) Physical efficiency measures
(Technical Efficiency) and (II) Value efficiency measures (Financial Efficiency). They can be
further categorized as: (I) Ratio measures and (II) Absolute or aggregate measures.

PHYSICAL EFFICIENCY MEASURES

a. Aggregate measures
1.Total Area of the Farm
2. Number of Livestock
3. Total Population

70
 b. Ratio measures
1.Land Use Efficiency
Some of the measures or indices measuring the rate of production are:

i. Yield per acre (production efficiency). The production efficiency of a farm with respect
to any particular crop enterprise can be expressed in terms of percentage as compared
with average yield of the locality.

An example: Wheat yield per acre of Farm ‘A’ = 13 qtls.

Average yield of the locality = 10 qtls.
Production efficiency of Farm ‘A’ = 13 x 100 = 130% 10

ii. Crop yield index. It is a measure of comparison of the yield of all crops on a given farm
with the average yields of these crops in the locality. The relationship is expressed in
percentage terms. This yield index is a convenient measure because it combines all the
yields into a single figure.

iii. Intensity of cropping.

It measures the extent of the use of land for cropping purposes during a given year. It is
expressed as a percentage.

Cropping intensity = Area cropped /Total cultivated area ×100

iv. Percentage of land under selected crops

2. Labour Efficiency Measures
By comparing the labour efficiency we can know whether the labour on a farm is more or less
than what is required. We can also find out whether the labour is relatively more or less efficient.

i. Crop acreage per man equivalent

The significance of this measure is influenced by the varying proportion of crops with high or
low labour requirements, such as potatoes compared with wheat. It is one of the simplest
measures and is computed by dividing the total acres in crops by man-equivalents.

ii. Productive. Man-work units per man-equivalent

It is another good and accurate general measure of labour efficiency for all types of farms. This
measure is computed by dividing total productive man-work units by the number of man-
equivalents on the farm. For average efficiency on most of the Indian farms a full-time worker
(man equi.) should accomplish at least 250 units per year. This measure can compare even farms

71
in different type-of-farming areas with different degrees of intensity or with varying crop
acreages and livestock. A productive man work unit is the average amount of work
accomplished by one man in the usual 10-hour day. The total productive man work units from a
given farm represent the number of 10-hour days required under average conditions and abilities
to do all the work necessary on the production of crops. The P.M.W.U. are obtained by
multiplying the acres of each crop and number of each kind of livestock by the average labour
requirements per unit of each enterprise in a region.

P.M.W.U. per man = Total P.M.W.U./Man Equivalents

3. Machinery efficiency
Horse power / acre of land available and used.
FINANCIAL EFFICIENCY MEASURES
Aggregate measures
i. Total capital managed
ii. Gross income
iii. Gross expenses
iv. Gross profit
v. Net worth = Total assets – Total liabilities
MEASURES OF FARM INCOME AND PROFIT EFFICIENCY

There are various measures which can be used to evaluate farm incomes and profits. The
measures listed below can be useful for such an analysis.

i. Net Cash Income. Total cash receipts from production minus total cash operating
expenses.
ii. Net Farm Income: Net cash income from production plus or minus change in inventory in
non-depreciable items and depreciation on power machinery, livestock, buildings, etc.
iii. Farm Earnings: Net farm income + value of farm privileges (farm products) used in
home.
iv. Family labour earnings. Farm earnings minus interest charges on farm capital.
v. Percent Returns to capital. Ratio of farm earnings minus imputed value of the family
labour to average, capital investment expressed in percent terms.
vi. Returns to management: Family labour earnings minus imputed value of the family
labour.
Ratio measures

i. Gross output per gross input

ii. Fertiliser cost per crop acres = Fertiliser cost / crop acres
iii. Power and equipment cost per crop acre= Total cost of machinery/ total crop acres
iv. Power and equipment / Investment per acre= Total Machinery investment / Total Crop
acres
72
 v. Cost ratios
• Operating cost ratio = Operating expenses/ Gross Profit
• Fixed cost ratio = Fixed expenses/ Gross profit
• Gross cost ratio = Total expenses / Gross income
• Cost per acre = Total expenses/ No of acres
vi. Capital ratios
• Capital per unit of gross profit = Total capital investment/ Gross income
• Capital per man
vii. Income ratios
• Rate of capital turn over = Gross income/ Total farm assets×100
• Net income per acre = Gross income – Gross expenses/ No of acres
viii. Financial solvency ratios
• Net capital ratio
• Working ratio
• Current ratio
Farm costing
Cost refers to the money value of effort expanded or sacrifice made in producing an article or
rendering a service or achieving a specific purpose.
Role of costs in farm management

• It helps in choosing from among varied alternative courses of action

• It helps in pricing decisions
• Costs helps in determining the optimum level of operation in accordance with the
behavior of cost in relation to scale of operation
• In deciding replacement of a capital equipment by a new one, cost information is vital
• In deciding whether to sell a produce at one stage of processing or to further process it,
cost data are needed.
• In deciding the acquisition of fixed assets, again cost is a relevant factor.
• To decide whether an equipment is to be bought or hired cost data are essential.
• Lastly, cost plays a vital role in performance evaluation and returns analysis.
Opportunity cost versus Actual cost

Opportunity cost refers to the value of benefits of a foregone alternative. Simply it means the
income from the missed alternative. It follows that the opportunity cost would arise only when
there are alternatives. It is specially used in resource allocation problems, when the resource in
question can be put to plural uses, but at one time.

Out of pocket versus Imputed cost

Out-of-pocket cost refers to cost that involves an actual outlay of cash immediately or in the near
future. Material cost, labour cost and interest on borrowed funds are examples for this. On the

73
other hand imputed cost does not involve actual outlay. It refers to assumed cost or hypothetical
costs. It includes the assumed cost of using owned resources for the business carried on by the
farm owner himself.

74
 Lecture No. 11.
Importance of farm records and accounts in managing a farm, various types of farm
records needed to maintain on farm, farm inventory, balance sheet, profit and loss
accounts.
Management of a farm business requires a wide range of information on physical and
financial performance. Farm book-keeping is known as a system of records written to furnish a
history of the business transactions, with special reference to its financial side. Records and
accounts help in evaluating the performance of the farm business, obtaining credit from financial
institutions, filing tax returns, evaluation of investment alternatives etc.

i. Advantages of farm records and accounts

The various advantages of keeping systematic farm records can be described as under:

1. Means to higher income

To obtain higher income, farmers must have exact knowledge about present and
potential gross income and operating costs.

2. Basis for diagnosis and planning

Diagnosis of management problems is the pre-requisites of sound planning. Records and

accounts provide the basic information needed for such a diagnosis.

3. Way to improve managerial ability of the farmer

The farmer gets a better insight into the working of his business, and farmer can avoid
mistakes and losses.

4. Basis for credit acquisition and management

Properly kept records and accounts can demonstrate and authenticate the production and
income potentials and credit worthiness of the farmer.

5. Guide to better home management

Records and accounts provide information on farm-household economy. Analysis of

farm records provides good guides for the allocation of resources between production improve-
ment and immediate family welfare.

6. Basis of conducting research in Agricultural Economics and production economics

Research requires precise and correct data which is possible only proper records and
accounts are maintained on the farm.

75
7. Basis for government policies

The farmers need to continuously feed the facts for state and nation, farm policies such as
land policies, price policies, and crop insurance, etc.

ii. Problems in Farm Accounting

a) As Indian farmers carry out only subsistence nature of farming, recording is not essential to
them.
b) Indian farmer acts as an owner, manager and labourer. Hence, recording becomes complex.
c) Illiteracy and lack of business awareness of farmers prohibit them to have farm records.
d) Fear of taxation prevents farmers from recording and accounting the information.
e) Forecasting becomes complicated because of very high risk and uncertainties involved in
farming.
A good system of accounts for any farm is one that enables recording information that the
farmer needs and also permits the desired analysis of the information recorded.

Systems of Book-Keeping

There are two systems of farm accountancy: (i) double entry system, and (ii) single entry system.

Double entry system

It is a method of recording each transaction in the books of accounts in its two fold aspects,
i.e. two entries are made for each transaction in the same set of books, one being a debit entry
and the other a credit entry.

Single entry system

This is the system which ignores the double effect of transactions. Only personal accounts
of debtors and creditors are kept and impersonal accounts are ignored altogether.

3. Types of Farm records: Farm records are usually of the following types:

(i) Farm inventory; (ii) Physical farm records; (iii) Financial farm records

There are many different kinds of farm records and accounts, each of which can be
adopted for a given purpose on a particular farm situation.

Farm inventory refers to the listing down the items possessed by the farm on a specified date
which includes inventory of crop and livestock, inventory of farm machinery, and farm building.

Physical Farm Records

76
 Physical records are related to the physical aspects of the operation of a farm business. They
do not indicate financial position or the outcome of the farm business, but simply record the
physical efficiency or performance of the farm.
Physical farm records normally include the following records:

i) Farm map, soil map and contour map, Stock register.

ii) Charts on physical efficiency,
iii) Land utilization record,
iv) Farm production and disposal record, Input registers,
v) Labour records, daily work diary and machinery use records.

Financial Farm Records which deal with the financial transactions can be recorded in four
main types of accounts. (a) Accounts dealing with external agencies; (b) Accounts dealing with
capital investment; (c) Operation accounts; and (d) Service accounts

The Following are the farm records maintained by the co-operate farms and state farms.

1. Forecast register
Field Area Nature Wage rates and labourers forecasted
of
work Skilled Wage Semi Wages Unskilled Wage
labourers rate Skilled rate labourers rate
Labourers
(in Rs.) (in (in Rs.)
Rs.)

Amount
Skilled Amount Semi-Skilled Amount Unskilled Amount
Labourers Labourers labourers
(in Rs.) (in Rs.) (in Rs.)

This is prepared a day in advance of the actual labour requirement on the farm. Keeping
in view of the various operation to be performed for various crops, the requirements is
forecasted. The labour units indicated in this register should not exceed the labour units given in
DMS.

Daily memorandum sheet (DMS)

Field Purpose of Allotment of labourers

work

Skilled Wages Semi Wages(in Unskilled Wages(in Amount(in

(inRs.) Skilled Rs.) Rs.) Rs.

77
 This deals with the distribution of work in a day along the labour units employed and the
wages paid for various operations.

1. Muster Sheets
S.No Name of Sex Nature No. of days No.of Wages Amount
the casual of work worked in a days rate/day(in (in Rs.)
labourers fortnight Rs.)

1 2 3 …..15

The particulars of the labour units employed including the number of days employed and the
wage bills are posted in these sheets. These sheets give an idea of fortnightly expenditure
incurred on the labour wages.

2. Permanent Dead Stock Register

Date Particulars Receipts Issues Balance

3. Temporary Dead Stock Register

Date Particulars Receipts Issues Balance

This register gives the managements an idea of the stock issued and balance available so that
future requirements can be assessed and undertake the purchase as and when required.

4. Fertilizer and chemicals register

S.No Date Particulars Receipts Issues Balance

The details of the different fertilizer purchased along with the purpose for which they are
issued are posted here. This register presents the position of the stock of fertilizers and chemicals
available at any given point of time.

7.Seed stock register (grams/kgs/nos.)

Date Particulars Receipts Issues Balance

78
 This register gives the details of the purchases, issues and balance of the seeds of
different varieties of crops grown on the farm.

8.FYM and cattle feed register (kgs/tonnes)

S.No Date Particulars Receipts Issues Balance

This register deals with the particulars of receipts, issues and balance of FYM and cattle feed.

9.Tractor expenditure register(Rs)

Date Particulars Receipts Issues Balance

This register contains the information pertaining to the purchase of items like diesel,
spare parts, etc and their use as per the requirements. The stock position of the same is also
available in this register.

10. Livestock Register

Date of From whom Description of Date of birth Book

purchase purchased/received the animal value(in Rs)

The description of the animal along with the source of obtaining the same and date of
birth of the animal and value are entered here.

11.Farm produce stock register

S. Dry land/ Season Main Entered in page Signature Signature of

No crop product no. of produce of the store the farm
Wet land variety (Qtls/ stock register keeper superintendent
tonnes)

The details of crop wise and variety wise main product and by product are entered here.
This gives an account of the total product obtained from the farm.

12.Produce stock register

Date Issue/sale Receipts Issues Balance

79
 The information posted in the farm produce stock register is brought over here. Under the
column “receipts” the quantity recorded in the farm produce stock register is entered here. The
issue column indicates the details as to whether the produce was issued to the farm or sold.

13.Indent register

Indent Date Particulars Quantity Purpose Receiver Indent Signature Signature of

No. of the the farm
store superintendent
keeper

The register presents the indents that are made. Under the column “purpose”, if the input
indented is fertilizers, the crop to which it is proposed to be applied is entered here. This register
holds good for all farm supplies.

14.Sales price register

S.No. Name of the Quantity Rates furnished Rate per unit Rate at
product proposed for by the secretary, in the local which
sale Regulated market market (Rs) disposed(R
committee (Rs) s)

Sales particulars of the produce obtained on the farm are found in this register. The rates
furnished by the agricultural market committee and that of local markets are obtained and then
the rates at which produce was disposed is entered. This type of information is mostly seen in the
Government farms.

15. Sanction Register

S.No. Date Particulars Quantity Rate Amt to be Head of Signature Signature

cum (unit Sanctioned the of farm of
purpose of price (Rs.) Account manager sanctioning
expenditure Rs.) authority

It provides the details of the items of expenditure along with the rate per unit and amount
to be sanctioned. The proposed items are purchased after due sanction from the concerned
authorities.

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16. Auction Register

S.No Name of Address Amount Signature Amount Signature

the of the (Rs.) of the deposited of the
bidder bidder bidder (Rs.) successful
bidder

The information of those items, which are auctioned, can be known from the auction
register.

17. Cash book

Date Opening Sales bill Amount Amount Cash on
Balance No. (Rs.) remitted to hand (Rs.)
the bank
(Rs.)

The details of cash remittances and cash on hand are shown here.

Thus the main objectivity of maintaining the records is to control the farm business,
guide future decisions and provide data required for sound farm planning.

81
Financial Statements :
There are three important financial statements. They are i) Balance sheet ii) Income
statement iii)Cash flow statement or Fund flow statement.

Net worth Statement or Balance sheet of a farmer as on 31st March 2006

Sl. Assets Value in Rs. S. Liabilities Value in

No. No. Rs.
I Current assets I Current liabilities
1. Paddy grains 25000 1. Wages for Farm labour
2. Seeds and fertilizers 1500 to be paid 500
3. Cash on hand 500 2. Interest to be paid 500
4. Savings in the bank 1000 3. Tax payable 1000
5. Poultry birds 2500 4. Crop loan 1000
6. Farm yard manure 800 5. Instalment for term loans
Sub Total 4000
Sub Total 31300 7000

II Intermediate assets II Intermediate liabilities

1. Milch animal 4200 1. Loan for animal 5000
2. Share in co-operative 2000
bank
3. Farm implements 800
Sub Total 7000 Sub Total 5000

III Long term assets III Long term liabilities

1. Land 150000 1. Long term loan 137000
2. Building 25000
3. Tractor 125000
Sub Total 300000 Sub Total 137000
Total 338300 Total 149000
Net worth 189300
Balance sheet

It shows the financial status of a business at a given point of time. It provides a snapshot
and may be regarded as a static picture. It is a systematic listing of all assets and liabilities of the
business. Its purpose is to reveal liquidity, solvency and wealth of the business of that particular
movement.

Income Statement

It is also called profit and loss account. It is the accounting report which summaries the
revenues, expenses and difference between them (or net income) for an accounting period.
Technically, the income statement is an adjunct to the balance sheet because it provides details
relating to the net income, which represents the change in owners’ equity between two

82
successive balance sheets plus dividends. Yet in practice it is often considered to be more
important than the balance sheet itself, because the details of revenues and expenses provided in
the income statement shed considerable light on the performance of the business.

Income statement of a farm for the year 200 5-2006

Sl. Source of income Amount Sl. Expenses Amount

No. in Rs. No. in Rs.
I Cash farm Income I Variable Cash Expenses
By sale of
1. Paddy 8000 1. Cost of feed 1500
2. Banana 5000 2. Cost of seed 2000
3. Tomato 3000 3. Cost of diesel 500
4. Milk 5000 4. Cost of labour 2000
5. Poultry bird 500 5. Cost of fertilizers 1000
Sub total 21500 Sub total 7000

II Net capital gain 1000 II Fixed cost 300

income
III Total farm income 22500 III Loan 2000
IV Off farm income 1000 IV Total cash expenses 9300
V Non farm income 2500 V Non cash adjustment 600
Total income 26000 VI Total farm expenses 9900
VII Capital investment
1. Implement 300
VIII Family expenditure 7000
IX Total expenses 17200

Cash/Fund Flow Statement

It shows the sources of funds and allocation of funds during the period. It is also referred
as the statement of changes in financial position or statement of sources and uses of funds, it
draws on the information contained in the basic financial statements. Fund flow analysis
provides an insight into the movement of funds and helps in understanding the changes in the
structure of assets, liabilities, and owners’ equity.

83
 Cash Flow Statement of a Farm for the year 2005-2006 (in Rs.)

Sl. Particulars July- October- January- April – June

September December March
No.
I Beginning cash balance 1000 2500 8000 8000
II Cash in flow
1. Sale of crop products - 5000 - 3000
2. Sale of milk 3000 3000 3000 3000
3. Sale of poultry - - 500 -
4. Loan received 3000 - - -
Sub total 6000 8000 3500 6000
III Cash outflow
1. Cultivation expenses 1500 1000 2000 500
2. Maintenance of livestock 1500 1500 1500 1500
3. Insurance -- -- -- 200
4. Tax -- -- -- 300
5. Repayment of loan -- -- -- 2000
6. Purchase of calf 1000 -- -- --
7. Purchase of implement 500 -- -- --
Sub total 4500 2500 3500 4500

IV Ending Cash Balance 2500 8000 8000 9500

Appraisal of Farm resources

Valuation of farm assets
Farm inventory is a complete listing of all that a farm owes at a particular date generally at the
beginning and the end each agricultural year. It includes not only the listing of physical assets
but values of all such assets, liabilities and debts as well. There are two steps involved in taking
a farm inventory.
1. Examination of physical Assets
It includes a complete listing of all the physical assets, including a verification of weights
and measures. The losses, wastages, shrinkages or gains which accrue over time are all
accounted for.

84
2. Valuation physical assets
After the physical assets have been examined and listed, it is important to value them.
Valuation
of farm inventories is an important step in the process of taking an inventory on a farm. The
nature and purpose of an asset generally determines the best method for its valuation. However,
a few common methods of valuation are discussed below:
Valuation at Cost: According to this method, the amount of money actually invested on the
assets when it was acquired is entered in the inventory. This method has the following
limitations:
(i) It cannot be used for the valuation of farm products.
(ii) The effects of inflation and deflation are ignored.
(iii) Original investment value has only a limited use when considered somewhere in the
middle of the business.
Net Selling Price: The method of valuation is generally applied to those assets which are
primarily held for sale on the farm. It represents market price less the selling costs. It is an
effective method of valuation for crops and livestock produced for the market. However, it
cannot be used for the valuation of buildings and machines for which no actual market may
exist.

Cost minus Depreciation: The method assumes that the p9urchase price of an assets
approximates its value. Thus, the value of the assets in subsequent years can be estimated by
subtracting the depreciation from its cost. This is a popular method for the valuation of
machinery and breeding livestock.

Cost or Market Price, whichever is less: In general, market price provides the best
approximation of its value. Farm supplies are generally valued using this method but it can
understate or overstate the value of an asset.
Replacement Cost: It represents a value of an asset which is equal to the cost to reproduce the
asset at the present prices and under the existing technological improvements. This method
may be successfully employed for the valuation of fixed and long-lived asset.
Replacement Cost Less Depreciation: It represent an improvement over the previous method
as it provides a more realistic valuation of fixed and long-lived assets like buildings, particularly
when wide price changes may occur. However, this method should be used very carefully as it
may often lead to over valuation.

Income Capitalization: For assets like land whose contribution towards the income can be
measured for each production period and have long life, income capitalization is an ideal

85
 method of valuation. The expected level of income is Rs.1000 per year, the present value of the
land then can be easily assessed by using this method, if the rate of interest is 10 per annum,
i.e.,

Thus, price of land in question would be valued at Rs.10,000. This method is generally used in
combination with other method.
In short,
(i) For all assets that will be sold within the year, use the net selling price.
(ii) For all farm supplies (inputs) use cost or market price whichever is lower.
(iii) For capital asset which includes machinery and breeding livestock, cost less depreciation is
the best method of valuation.
(iv) For farm buildings, if constructed a long time ago, use the replacement less
depreciation method, For other building, constructed only a few years ago use the cost less
depreciation method.
(v) For farm land, use the Income capitalization method to obtain its present value.

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 Lecture 12.
Meaning and importance of farm planning and budgeting, partial and
complete budgeting, steps in farm planning and budgeting - linear
programming, appraisal of farm resources, selection of crops and livestock’s
enterprises
A. FARM PLANNING
A successful farm business is not a result of chance factor. Good weather and
good prices help but a profitable and growing bus iness is the product of good
planning. With recent technological developments in agriculture, farming has
become more complex business and requires careful planning for successful organization.
Farm planning is a decision making process in the farm busine ss, which
involves organization and management of limited resources to realize the specified
goals continuously. Farm planning involves selecting the most profitable course of
action from among all possible alternatives. A farm plan is a programme of total
farm activity of a farmer drawn up in advance.

i) Objectives of Farm Planning

The ultimate objective of farm planning is the improvement in the standard of
living of the farmer and immediate goal is to maximize the net incomes of the
farmer through improved resource use planning. In short, the m ain objective is to
maximize the annual net income sustained o ver a long period of time. The farm
planning helps the cultivator in the following ways:

a) It helps him examine carefully his existing resource situati on and past
experiences as a basis for deciding which of the new alternative enterprises and
methods fit his situation in the best way.

b) It helps him identify the various supply needs for the existing and improved
plans.

c) It helps him find out the credit needs, if any, of the new plan.

d) It gives an idea of the expected income after repayment of loans, meeting out the
expenditure on production, marketing, consumption, etc.

e) A properly thought of a farm plan might provide cash incomes at points of tim e
when they may be most needed at the farm.
A farm plan is a programme of total farm activities of a fa rmer drawn out in
advance. An optimum farm plan will satisfy all the resource constraints at the farm
level and yield the maximum profit.
87
ii) Characteristics of a Good Farm Plan

A good farm plan generally should have the following characteristics:

a) It should be written and flexible,

b) An element of flexibility in a farm plan is essential to account for changes in the

environment around the farm.

b) A farm plan should maximize the resource use eff iciency at the farm.

c) It should provide for the attainment o f the objectives of profit maximization

through optimum resource use and balanced combination of farm enterprises. Which
ensure;
1. Production of food, cash and fodder crops.
2. Maintain soil fertility.
3. Increase in income.
4. Improve distribution of and use of labour, power and water requirement throughout the year.

d) Risk and uncertainty can be accounted for in a good farm plan.

e) it use latest technology and provide efficient marketing

e) The plan helps in timely acquisition and repayment of farm credit.

iii) Components of Farm Planning: Any systematic farm planning necessarily has
the following five components:

a) Statement of the objective function: Many farmers aim at profit maximization.

However, some farmers do not go all out to maximize their profits, but hav e
objectives like cereal requirements for the family and fodder needs for the
livestock.

b) Inventory of scarce resources and constraints

1) Land: Location, topography, soil type, fertility, drainage, irrigation systems and
so on affect enterprises in many ways and hence, it is useful to divide all the land
on a farm into different enterprises.

2) Labour: On subsistence farms, all labour is supplied by the farmer and his
family. Thus, it is important to record the number of workers - male, female and
children - and the type of manual work each is prepared is undertake. However, in
commercial farms, hired labour constitutes a major component of costs and thereby

88
inviting more attention in the planning process.

3) Capital: Whether fixed, like buildings and machines, or circulating, like cash in
hand or in the bank, capital acts as a very powerful constraint.

4) Personal: Farmers’ past experience, attitude t owards risks and uncertainties and
personal likes and dislikes influence the choice of enterprise.

5) Institutional: Market often serves as a constraint for the production of

vegetables, poultry, milk, etc. Even if the location of the farm is suitable for a
particular crop (commodity), a contract may still have to be obtained. E.g.
Sugarcane growing near the sugar mills. Similarly, though many parts of Himachal
Pradesh are suitable for poppy cultivation, the government has banned its
cultivation.

6) Rotations: Maximum permissible area under a part icular crop in a given season
or minimum area constraints imposed on the acre under some crops like legumes
would serve in maintaining soil fertility and help controlling pest and diseases.

3) Alternative Choices: Alternative choices in planning refer to t he various

enterprises, crops and livestock, which can be conside red for attaining the stated
objectives. There are alternate ways to use the scarce farm resources. There may be
more than one ways to produce the sam e enterprise. A comprehensive list of
different alternative enterprises can be prepared.

4) Input Output Co-efficient: The requirements of each of the several scarce

resources and the financial returns per unit of each enterprise or activity need to be
considered here. The precision in planning d epends more on accurate input -output
data than on the technique of planning.

5) Planning Technique: With a proper understanding of the planning environment

and use of precise input-output data along with true and re alistic constraints,
sophisticated techniques give better results. However, common sense in the
planning process could lead to fairly good results. Some of the farm planning
techniques are as listed below:

1. Budgeting.
2. Linear Programming.
Budgeting is most informal of all the planning techni ques and the level of
sophistication gradually increases as we mo ve from budgeting to linear
programming.
iv) Steps in Farm Planning: The various steps involved in planning are discussed
89
below:

a) Planning: This includes the identification and definition o f the problem,

collection of information, identifying alternative solutions and analyzing each
alternative. Planning is the basic management function as it means deciding on a
course of action, procedure or policy. The control function is a source of new
information, as the results of the initial plan become known.

b) Implementation: Once the planning process is completed, the best alternative

must be selected and action should be taken to place the plan into operati on. This
requires the acquisition and organization of necessary land, labour, capital and
other inputs. An important part of the implementation function is the financing of
the necessary resources.
c) Control: This provides for observing the results of the implemented plan to see
if the specified goals and objectives are being met. Many things can cause a plan to
go “off its track”. Price and other changes, which occur after the implementation of
the plan, can cause the actual results to deviate from the ex pected. Control requires
a system for making regular checks on the plan and monitoring progress and result s
as measured against the established goals. The dashed line in the chart represents
the continuous flow of information from the control function back to planning, an
important part of the total system. Without some feedback procedure, the
information obtained by the control system is of no use in making corrections in the
existing plan or improving future plans. This feedback sets up a continuous cyc le of
planning, implementation, monitorin g and recording progress, followed by a
reevaluation of the plan and the implementation procedures using the new
information obtained through the control function .

90
 PLANNING
Draw up alternative plans

IMPLEMENTATION
Select A plan and put it into operation

CONTROL
Analysis and evaluate progress of plan over time

Yes
Are planning objectives being achieved

Yes No
Does the remedy lie within the farmer’s control

Chart 14.1 Steps in Farm Planning

B. BUDGETING
Budgeting can be used to select the most profitable plan from among a number of alternatives
and to test the profitability of any proposed change in plan. It involves testing a new plan before
implementing it, to be sure that it will improve profit. It may be defined as a detailed physical and
financial statement of a farm plan or of a change in farm plan over a certain period of time.
Farm budgeting is expression of farm plan in monetary terms through the estimation of
receipts, expenses and profit is called farm budgeting.
i) Types of Farm Budgeting: The following are the different types of farm budgeting
techniques:
a) Partial Budgeting.
b) Enterprise Budgeting.
c) Cash flow Budgeting.
d) Complete Budgeting.

a) Partial Budgeting: This refers to estimating the outcome or returns for a part of
the business, i.e., one or few activities. A partial budget is used to calculate the
expected change in profit for a proposed change in the farm business. A partial
budget contains only those income and expense items, which w ill change, if the
proposed modification in the farm plan is implemented. Only the changes in income
and expenses are included and not the total values. The final result is an estimate of
the increase or decrease in profit. In order to make this estimate, a partial budget
systematically, answers to following four questions relating to the proposed change:
1) what new or additional cost will be incurred?
2) What current income will be lost or reduced?
3) What new or additional income will be received? and
4) What current costs will be reduced or eliminated?
91
 The first two questions identify changes which will reduce profit by either
increasing costs or reducing income. Similarly, the last two questions id entify
factors which will increase profit by either generating additional income or
lowering costs. The net change in profit can be computed by estimating the total
increase in profit minus the total reduction in profit. A positive value indicates that
the proposed change in the farm plan will be profitabl e. All the changes in farm
plan that can be appropriately adapted with the help of a partial budget can be
grouped into three types. They are as given below:

1) Enterprise substitution: This indicates a complete or partial substitution of one

enterprise for another. E.g. Substituting one acre of paddy for one acre of
Sugarcane.

2) Input substitution: Changes involving the substitution of one input for another
or the total amount of input to be used are eas ily analyzed with a partial budget.
E.g. substituting machinery for labour.

3) Size or scale of operation: Included in this category would be changes in total

size of the farm business or in the size of a single enterprise. E.g. Buying or renting
additional land or machinery.
Table 18.1 Introduction of Soyabean as an Intercrop in Sugarcane

Debit (Added Cost) Amount (Rs) Credit (Added Return) Amount (Rs)
1. Added Cost: 280.00 1. Added Return 1200.00
i) Labour
ii) Seed 20.00 2. Reduced Cost -
Sub- Total 300.00 Total 1200.00
2. Reduced Return -
Total 300.00
Net change in income=Added return – Added cost = Rs. 1200 – 300 = Rs. 900
1. Additional costs
A proposed change may cause additional costs because of a new or expanded enterprise
requiring the purchase of additional inputs.
2. Reduced income
Income may be reduced if the proposed changes would eliminate an enterprise, reduce the size of
an enterprise or cause a reduction in yield.
3. Additional income
A proposed change may cause an increase in total farm income if a new enterprise is being
added, if an enterprise is being expanded or if the change will cause yield levels to increase.

92
4. Reduced costs
Costs may be reduced if the change results in elimination of an enterprise, or reduction in size of
an enterprise or some change in technology which decreases the need for variable resources.

i) Limitations of partial budgeting technique

1. Partial change does not always provide a complete solution.

2. The results of partial budgets are subject to variations in output - input

prices, availability of resources and variations due to soil type, soil fertility etc.

b) Enterprise Budgeting: Enterprise is defined as a single crop or livestock

commodity. Most farms consist of a combination of several enterprises. An
enterprise budget is an estimate of all income and e xpenses associated with a
specific enterprise and an estimate of its profitability. It is pre -requisite for the
preparation of a complete farm budget or for the applicat ion of farm planning
techniques like linear programming. An enterprise budget lists dow n all the
expected output, both in physical as well as value terms, for a unit of a particular
activity (i.e., per hectare, per animal or per 100 birds) on the farm. The enterprise
budget is important since it depi cts the relative profitability of differen t enterprises
or activities or alternatives, which can be used to determine the relative dominance
of different enterprises. It includes variable cost or total operating cost and fixed
cost including depreciation and interest on fixed asset. Any enterpris e budget can
also be analyzed in terms of cash versus non -cash

expenses and total cost versus actual cash outlay.

Table 18.2 Enterprise Budget for Irrigated Groun d - Nut
Particulars Amount (Rs)
I Returns
1. Main product 6277
2. By product 524
3. Gross return 6801
II Cost
1. Land revenue 21
2. Seed 1245
3. Manures and fertilizers 530
4. Plant protection chemicals 98
5. Irrigation charges 190
6. Machine power 206
7. Bullock power 304
8. Human labour 1617
9. Interest on working capital 128

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10. Depreciation on buildings and machineries 125
11. Interest on Fixed capital 725
Total cost 5189
Net return 1612

c) Cash - Flow Budgeting: It is essential to know about cash flow statement before
using the cash flow budgeting.

1) Cash Flow Statement: It summarizes the magnitude of cash inflows and

outflows over a period of time.

2) Importance of cash flow Statement: It helps to assess: i) whether cash would be

available in correct quantity at right time; ii) whether the surplus could be
profitably diverted and iii) timing and magnitude of borrowings required. The cash
flow statement may be constructed over annually, qua rterly, monthly and weekly
depending upon the nature of business.

i) Cash inflows represent the amount of cash received during the particular time
period. It includes: a) the beginning cash balance, b) receipts through sales of farm
and non-farm assets and c) receipts of short term (operating), inter mediate and long
term loans.

ii) Cash Outflows represents the expenses incurred in a given period of time. It
includes: a) Cash expenses (variable cash expenses, fixed cash expenses, non -farm
investment, and personal expenses), b) Repayment on operating (c rop) loans and c)
repayment on intermediate and long-term loans.

Cash flow analysis indicates the amount of cash flowing into and out of the farm
business over a specific period of time. Cash flow statements and income
statements both show inflows and outflows of money, but differ in their treatme nt
of several important accounting entries. A cash flow statement includes non -farm
items such as income taxes, non -farm income and living expenses and gives a
complete accounting of debt transactions by showing pr incipal payments and
proceeds of new loans, whereas the income statement shows only interest payments.

3) Cash Flow Budgeting: A cash flow budget is a summary of the cash inflows and
outflows for a business over a given time period. As a forward planning t ool, its
primary purpose is to estimate future borrowing needs and the loan repayment
capacity of the business. Cash flow budgeting is to assess the whole farm plan.

94
 Table 18.3 Simplified Cash-Flow Budget
(Amount in Rs)
Particulars Time Period I Time Period II
1. Beginning cash balance 1000 1000
Cash inflow
2. Farm products sales 2000 12000
3. Capital sales 0 4500
4. Miscellaneous cash income 0 500
5. Total cash inflow 3000 18000
Cash outflow
6. Farm operating expenses 3500 1800
7. Capital purchases 10000 0
8. Miscellaneous expenses 500 200
9. Total cash outflow 14000 2000
10. Cash balance (5 – 9) - 11000 16000
11. Borrowed funds needed 12000 0
12.Loan repayment(principal and interest) 0 12720
13. Ending cash balance (10 + 11 – 12) 1000 3280
14. Debt outstanding 12000 0

Here, two time periods are considered. In the time period I, there is Rs.3, 000
cash inflow and Rs.14,000 cash outflow, leaving a projected cash balance of -
Rs.11,000. This would require a borrowing of Rs.12,000 to permit Rs.1000
minimum ending cash balance. The total cash outflow in the period II is Rs.18,000
which leaves a projected cash balance of Rs.16,000 and it permi ts paying off the
debt incurred in period I, estimated at Rs.12,720 when interest is included. The
final result is an estimated Rs.3,280 cash balance at the end of second period.
The primary use of a cash flow budget is to project the timing and amount of new
borrowing; the business will need durin g the year and the timing and amount of
loan repayments.

d) Complete or Whole Farm Budgeting: It is a technique for assembling and

organizing the information about the whole farm in order to facilitate decisions
Table 18.4 Complete Budget Showing Projecte d Income,Expenses and Profit.
Particulars Amount (Rs)
I Income: i) Cotton 54,000
ii) Paddy 43,000
iii) Sorghum 13,500
iv) Dairy products 40,000
Total income 150,500
II Variable Expenses: i) Fertilizers 11,900

95
 ii) Seeds 3,600
iii) Plant protection chemicals 7,900
iv) Fuel and oil 4,050
v) Machine repairs 2,650
vi) Feed purchase 1,600
vii) Veterinary expenses and other expenses 30,100
viii) Custom hire charges 10,250
ix) Miscellaneous expenses 2,450
Total variable Expenses 74,500
III Fixed Expenses: i) Tax 2,600
ii) Insurance 1,250
iii) Interest on debt 22,000
iv) Machinery depreciation 7,200
v) Building depreciation 3,200
Total fixed expenses 36,250
Total expenses 110,750
Net Farm Income (Rs. 150,750 – 110,750 ) 39,750

about the management of farm resources. It attempts to estimate all items of costs
and returns and it presents a complete picture of farm business. It is generally used
by beginners or by those farmers who want to completely overhaul their existing
farm organization and operation. Complete and part ial budgeting are mutually
complementary, i.e., the partial budgeting should be used at various stages of
complete budgeting in order to decide the changes to be effected in the farm
organization. The process of complete budgeting involves:

i) appraisal of existing farm resources, their uses and eff iciency,

ii) appraisal of alternatives or opportunities or various production activities
that can be included and their resource requirements and
iii)preparing and evaluating the alternative plans for their fea sibility and
profitability.
The above table shows an estimated profit or net farm inc ome of Rs.39,750,
if the prices and yield are actually realized. Changes in any of these factors will
obviously affect the actual profit received from operating the farm under this plan.

1) Uses:i) It provides a basis for comparing alternative plans for p rofitability. This
can be particularly useful when planning is carried out for growth and expansion.
ii) A detailed whole farm budget showing the estimated profit can be used to
borrow the necessary operating capital.

96
2) Difference between Complete Budgeti ng and Partial Budgeting:
Complete Budgeting Partial Budgeting
1. accounts for drastic changes in the 1. It treats minor changes only
organization and operation of the farm
2. All the available alternatives are considered 2. considers two or a few alternatives only
3. It is used for estimating the results of entire 3. It helps only to study the net effects in terms
organization and operation of a farm of costs and returns of relatively minor
changes
C Linear Programming:

George Dantzing (1947) developed the simplex method for optimal transport of
ammunition quickly with minimum cost. Linear programming is a mathematical method of
analysis, which finds the “best” or optimal combination of business activities to meet a certain
objective. Three components are needed to solve a problem with linear programming
technique. They are: 1) a desire to maximize or minimize some objective, 2) a set of activities or
processes available to accomplish this objective and 3) a set of constraints or restrictions that
limit one’s ability to achieve this objective.
Definition of L.P.
Linear programming is defined as the optimization (Minimization or maximization) of a
linear function subject to specific linear inequalities or equalities.
n
Max Z  C j X j
j =1
n
Subjected to a
j =1
ij X j  bi i=1 to m

Xj 0

Where;
cj= Net income from jthactivity
xj= Level of jthactivity
aij= Amount of ithresource required for jthactivity
b i = Amount of i t h resource availab

1) Basic assumptions of Linear Programming

i) Proportionality or linearity: Linear relationship exists between activity and

resource. For example, if one acre requires 30 man days, 100 Kgs of nitrogen and
Rs.60 of other variable expenses to produce 20 quintals of maize output, then 10
acres of maize would require exactly 10 times of each resource to produce 200
quintals of output.

ii) Additivity: The total amount of resources used by several enterprises on the
97
farm must be equal to the sum of resources used by each individual enterprise.
Hence no interaction is possible. The same is true for the products also.

iii) Divisibility: Fractions can be used and ent erprises can be produced in fractional
units. Resources and products are infinitely divisible.

iv) Non-negativity: None of the activity is negative.

v) Finiteness: Number of activities and constraints are finite.

vi) Certainty: Almost all planning techniques assume that resources, supplies,
input - output coefficients and prices are known with certainty.
Advantages of L.P
1. Allocation problems are solved.
2. Provides possible and practical solutions..
3. Improves the quality of decisions.
4. Highlights the constraints in the production.
5. Helps in optimum use of resources.
6. Provides information on marginal value products (shadow prices).
Limitations
1. Linearity
2. Considers only one objective for optimization.
3. Does not consider the effect of time and uncertainty
4. No guarantee of integer solutions
5. Single valued expectations.
2) Concepts used in Linear Programming
i) Solution: A solution refers to any set of activit ies Xj, j = 1, 2, 3, ..., n, which
satisfies a system of inequality constraints. The re may be innumerable solutions to
a given linear programming problem.
ii) Feasible Solution: Any solution to a linear programming problem is said to be
feasible, if none of the Xj is negative.

iii) Infeasible Solution: It refers to a solution, where some of the variables, Xjs,
appear at a negative level.

iv) Optimum Solution: One of the feasible solutions is optimum, provided a

feasible solution exists. Such a feasible solu tion, which optimizes the objective
function, is called an optimum solution. The set of Xj in this case satisfies the set
of constraints and non-negativity restrictions and also maximizes the objective
function.

v) Unbounded Solution: Many a time, faulty formulation of a linear programming

problem may result in an arbitrarily large value of the objective function and the

98
problem has no finite maximum value of profit. It represents a case of unbounded
solution to a linear programming problem.

3) Estimation of Optimum Solution using Linear Programming : The estimation

of optimal solution using linear programming is given in table 18.5.

Table 18.5 (a) Estimation of Optimum Solution using Linear Programming

Particulars Per Acre of Paddy Per Acre of Ground-Nut

Income and Expenses
1. Gross income 2600 2000
2. Total cost 1100 600
3. Net income 1500 1400
Resource Requirements
1. Acres of crop- land 1 1
2. Hours of labour during 45 60
harvesting
3. Rupees of operating 1100 600
capital
Table 18.5 (b) Estimation of Optimum Solution using Linear Progra mming
Particulars Amount Paddy Ground-nut
Available Per Maximum Per Maximum
Acre Area (Acres) Acre Area (Acres)
Needs Required Needs Required
1. Maximum land. 4 acres 1 4.00 1 4.00
2. Maximum 225 hours 45 5.00 60 3.75
hours.
3.Maximum Rs. 3500 1100 3.18 600 5.83
operating capital.

There is also one additional restriction the farmer wants to incorporate into the
analysis. He wants a farm plan that has at least 0.7 acres of paddy. The line that
connects points A, B, C, D and E in the figure 18.1 def ines an area which contains
all numerous combinations of paddy and groundnut that can be produced on this
farm. This region is called the feasible region of production. At any point outside
this line, the farmer could not produce that

99
 Maximum land
constraint

S Maximum land
constraint
Grou Iso
ndnu Revenue
B Cline
t
D Maximum labour
constraint Minimum paddy area
constraint

O A E T Paddy
combination of paddy or groundnut without isolating any one of the constraints.
In order to complete the graphic analysis, it is necessary to find out the optimal combination of
paddy and groundnut that maximizes the net returnto the fixed resources of land, labour and
operating capital and minimum acreage requirements. This is done by defining a line that will
give a constant amount of net revenue, given different acreage combinations of paddy and
groundnut. The slope of the iso revenue line is calculated by the following equation.
Net revenuew for paddy 1500
slope of Isorevenue line= = = 1.071
net revenue for groundnut 1400
Since the iso revenue line indicates a set of net revenues, it is the farmer’s desire to find an iso
revenue line as far away from the origin as possible. The farther away the iso revenue line, the
greater the net income. In addition, he needs to be concerned that the iso revenue line is
within the feasible region of production. The iso revenue line S and T fulfils both of these
requirements. Thus, the production levels indicated at corner point D achieves the maximum
level of net Income.

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 Table 18.6 Optimum Solution Using Graphical Method of Linear
Programming
Particulars Non Optimal Plans Optimal Plan
A B C E (D)
1. Acres of Paddy 0.70 0.70 1.00 3.18 2.20
2. Acres of ground nut 0.00 3.23 3.00 0.00 1.80
3. Total net income (Rs) 1050 5565 5700 4770 5820
4. Total crop land used 0.70 3.93 4.00 3.18 4.00
5. Total harvesting labour used 31.5 225 225 143 207
6. Total operating capital used 770 2705 2900 3500 3500

The optimal plan is growing of 2.20 acres of paddy and 1.80 acres of gro undnut.
It has a total net income of Rs.5620. This plan utilizes all the 4 acres of crop land
and Rs.3500 of capital. However, not all labour is used in this plan, with 1 8 hours
being unused (225 - 207). The non-optimal plans like A, B, C and E have lesser net
income than that of optimal plan (D).

4) Difference between Farm Budgeting and Liner programming:

Farm budgeting Linear programming

1. Method of estimating expected income, 1. Optimization of linear function subject to
expenses and profit for the farm business linear inequalities or equalities.
2. Non mathematical tool 2. Mathematical programming mode ls
3. It is a trial and error method 3. It offers a mechanical process of calculations
in the selection of products
4. Computation become tedious and 4. Computations are easy.
cumbersome.

101
 Lecture 13
Concept of risk and uncertainty occurs in agriculture production, nature and sources of
risks and its management strategies

Frank knight classified the knowl edge situation into the following logical
possibilities

KNOWLEDGE SITUATION

PERFECT IMPERFECT

RISK UNCERTAINTY

A PRIORI STATISTICAL

i) Perfect Knowledge: Under this situation, technology, prices and institutional

behaviour would be known with certainty for an y period of time in future. However,
this situation does not reflect the real world situation.
ii) Imperfect Knowledge: An imperfect knowledge situation can be classified
either as risk or uncertainty. Risk represents less imperfection in knowledge than
does uncertainty. Under risk, the occurrence of future events can be predicted fairly
accurately by specifying the level of probability. When a risk situation prevails, at
the time of harvesting paddy, the chances for a cyclone are 5: 95 or 20: 80. Apriori
risk prevails, when sufficient advance infor mation is available about the occurrence
of an event. E.g. the probability of a head or a tail turning up is 50: 50, if an
unbiased coin is tossed. Contrary to this, statistical risk can only be predicted on
the basis of occurrence of several observations made in the past. Mortality tables of
insurance companies provide good examples of statistical risk. An insured vehicle
meeting with an accident or an insured house catching fire or being burgled can be
assigned probabilities based on the past experience o f any country. Because of the
quantification of imperfect knowledge- under risk situation, the event can be
insured. If the occurrence of an event cannot be quantified with the help of
probability, then that situation is called uncertainty. Thus, fut ure occurrence of an
event cannot be predicted. Therefore, it becomes essential to formulate some
estimates, however wild, of the most likely outcomes. E.g. price uncertainty.

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 Farmers must make decisions on crops to be planted, seeding rates, fertilizer levels
and other input levels early in the cropping season. The crop yield obtained as a result of these
decisions will not be known with certainty for several months or even several years in the
case of perennial crops. Changes in weather, prices and other factors between the time the
decision is made and the final outcome is known can make previously good decision very
bad.
Because of time lag in agricultural production and our inability to predict the future
accurately, there are varying amounts of risk and uncertainty in all farm management
decisions. If everything was known with certainty, decision would be relatively easy. However,
in the real world more successful manager are the ones with the ability to make the best
possible decisions, and courage to make them when surrounded by risk and uncertainty.
Definition of risk and uncertainty
Risk is a situation where all possible outcomes are known for a given management decision
and the probability associated with each possible outcome is also known. Risk refers to
variability or outcomes which are measurable in an empirical or quantitative manner. Risk
is insurable.
Uncertainty exists when one or both of two situations exist for a management decision.
Either all possible outcomes are unknown, the probability of the outcomes is unknown or
nether the outcomes nor the probabilities are known. Uncertainty refers to future events
where the parameters of probability distribution (mean yield or price, the variance, range or
dispersion and the skew and kurtosis) cannot be determined empirically. Uncertainty is not
insurable.
Sources of risk and uncertainty
The most common sources of risk are.
1. Production risk: Crop and livestock yields are not with certainty before harvest or final
sale weather, diseases, insects, weeds are examples of factors which can not be accurately
predicted and cause yield variability.
Even if the same quantity and quality of inputs are used every year, these and other factors
will cause yield variations which cannot be predicted at the time most input decision must
be made. T he yield variations are examples of production risk.
Input prices have tended to be less variable than output prices but still represent
another source of production risk. The cost of production per unit of output depends on both
costs and yield. Therefore , cost of production is highly variable as both input prices and

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yield vary.
2. Technological risk: Another source of production risk is new technology. Will the new
technology perform as expected? Will it actually reduce costs and increase yields? These
questions must be answered before adopting new technology.

3. Price or marketing risk: Variability of output prices is another source of risk.

Commodity prices vary from year to year and may have substantial seasonal variation within
a year. Commodity prices change for number of reasons which are beyond the control of
individual farmer.
4. Financial risk: Financial risk is incurred when money is borrowed to finance the
operation of farm business. There is some chance that future income will not be
sufficient to repay the debt. Changes may take place in the interest rates, scale of finance,
and ability of the business to generate income.
iii) Types of Risks and Uncertainties: Risks and uncertainties can be classified into the
following five categories.
a) Economic Uncertainties: In general, farmers in most countries face differences in price for the
inputs and outputs from what they might have anticipated at the time of preparing farm plan.
b) Biological Uncertainties: Rain or storm, drought and also by increased incidence of pest and
diseases may all affect the yield in agriculture directly or indirectly.
c) Technological Uncertainties: Technological improvement implies that the same level of
input can now produce larger
quantity of produce. The
Y T upward shift in the
production function signifies
1
Y T 1 that more output can be
produced at each level of
0 0 input after technological
progress. This effect would
be due to the delayed
operation of the law of
Output
diminishing marginal returns.
Thus, improvement of
knowledge or technological
progress, which is a
Input X continuous phenomenon,
Fig 13.1 Upward shift of production function due to may render some techniques
Technological progress 0 less efficient and finally
obsolete.

In the fig.13.1, for the same input level X 0 , the yield is increased from Y 0 to Y 1 due
to technological improvement from T 0 to T 1 .

d) Institutional Uncertainties: Institutions like government, bank, etc may also

cause uncertainties for an individual farmer. Crop cess, credit squeeze, price

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supports, subsidies, etc. may be enforced or withdrawn without taking an individual
farmer into confidence. This type of uncertainty may also result in non -availability
of resources in appropriate quantity and at the appropriate time and pl ace.

e) Personal Uncertainties: The farm plan may not be executed or delayed

because of some mishap in the farmer’s household or in his permanent labour force.

iv) Safeguards Against Risks and Uncertainty

Some farmers take more risk than others. However, all farmers use one or more measures
of different types to safeguard themselves against risks and uncertainties on their farms. The
various measures generally used to counter risks and uncertainties in agriculture are as follows:
1) Selection of enterprises with low variability: There are certain enterprises where the yield
and price variability are much lower than for others. For example, rice has relatively much less
variability in its yields and prices than tomato. Thus, the inclusion of enterprises with low
variability in the farm plans provides a good way to safeguard against risks and uncertainties. In
practice, the data on yields and prices of different enterprises over a period of time may be used
to measure the extent of variability by using statistical concepts like variance or co-efficient of
variation.
n

(X i − X )2
Variance = i =1

n
Standard Deviation= Variance
SD
Coefficient of Variance(%)= x100
Mean
Table 15.1 Estimates of Farm Income
Year Farm Income (Rs / Year) (Xi – X) 2
1996 2500 688900
1997 3000 108900
1998 3200 16900
1999 3800 220900
2000 4150 672400
Total 16650 1708000
Mean = 3330; Standard Deviation = 1708000/5 = 584.4656
CV = 584.4656 / 3330 = 17.55 per cent.
2) Discounting Returns: At this stage,we refer to discounting only as a function of
risk and uncertainty, and not time. In terms o f the profit maximization condition of
VMP = Px, discounting means that either the output price (Py) is decreased or input
price (Px) is increased by some proportion or it can be of both. Thus, t he profit

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maximization level of the variable input X 1 may now be lower with discounting
than otherwise.

3) Insurance: Insurance covers the cost to some extent so as to minimize the loss.

4) Forward Contracts: They reduce the future prices of both inputs an d outputs
into certainty. Pre-harvest contracts of mango, sha re cropping, i.e., forward contract
in kind are some examples for this.

5) Flexibility: This refers to the convenience with which the organization of

production on a farm can be changed.

a) Time Flexibility: Time flexibility may be introduced either throug h proper

selection of products or production methods or partly by both. Orchard plantation is
a relatively rigid enterprise than annual crops. A short -lived farm structure is more
flexible that the durable.

b) Cost flexibility: Wherever time flexibility is of limited use, cost flexibility

becomes important. Cost flexibility refers to variations in output within the
structure of a plant of a longer life. Extension or concentration of output, whenev er
desired by favourable prices or yields can be brought abou t at lower cost for a given
farm (plant). Owning rather than custom hiring a power tiller may have more cost
flexibility.

c) Product flexibility: Product flexibility aims at changes in production in response

to price changes. In this category, machines, fa rm structure, etc, can be readily
shifted from one product to another.

6) Liquidity: This refers to the case with which assets in a farm can be converted
into cash, the most “liquid” of all asset s. If some of the assets are held in the form,
which can be easily converted, into cash, it provides a safeguard to the farmer by
enabling him to make necessary adjustments in response to risks and uncertainties
of various types.

7) Diversification: It is a means of stabilizing incomes rather than profit

maximizing technique relating to receive benefits of complementarity or
supplementarity. Under risky environment, a farmer may not specialize in a single
enterprise over a period of time even if substitutio n and price ratios may so dictate
as discussed under product-product relationship. Instead, he may choose
several enterprises in some proportion overtime, so as to distribute the risk factor.
Like flexibility, it has no provision to reap large gai ns due to high prices or yields
over time, but serves as a good method to prevent heavy losses. However, the
diversification of farm activities may deprive the entrepreneur of all the advantages
of specialization.
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8) Maintenance of resources in reserve: Many a time, there is a risk or uncertainty
about the availability of the right inputs, in the required quantity at the right time
and place and at a reasonable price. This may be due to the imbalance between
demand and supply of the resources. To overcome t his problem, the best way is to
maintain sufficient stocks of such inputs. Maintenance of sufficient stocks depends
on the availability of funds, his ability to fore cast prices and the availability of
resources and storage facilities in the farm.
9) Adjustment to uncertain of Inputs: When a resource is not available, the best way the
farmer can safeguard against such risk and uncertainty is by exploring the use of some other
resource as a substitute. If a farmer is uncertain about the availability of inputs, he would do
better by choosing the best alternatives, i.e., sowing the second best variety, using the second
best fertilizer, using the second best method of harvesting etc.
10.Minimum support price: The government purchases the farm commodity from the farmers if
the market price falls below the support price.

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 Lecture No. 14.
Crop/ Livestock/ machinery insurance. Weather based crop insurance – Features and
Determinants of compensations
Crop insurance is the primary risk management tool farmers use to financially recover
from natural disasters and volatile market fluctuations; pay their bankers, fertilizer suppliers,
equipment providers and landlords; purchase their production inputs for the next season; and
give them the confidence to make long term investments that will increase their production
efficiency. A financially healthy rural economy requires a financially healthy farm production
sector. Furthermore, by 2050, the United Nations projects a 33 percent increase in the global
population with at least a 70 percent increase in demand for food. As the number of consumers
expands globally and the climate continues to exhibit more intense weather events, there will be
increasing pressure on the global food production system. Recent development in crop insurance
shcems and various products are discussed below.

Experimental crop insurance schemes

In reality, crop insurance had already emerged, though on a small-scale, experimental

basis. During 1973—76, fertilizer companies, such as Gujarat State Fertiliser Company in
Gujarat and Rashtriya Chemicals and Fertilisers Company in Maharashtra, started pilot crop
insurance schemes as components of agricultural extension projects. Similar experimental
schemes were started in Andhra Pradesh, Karnataka, Tamil Corporation of India (GIC) from its
inception in 1973 until 1976-covered cotton, wheat, groundnut and potato crops, and 2,154
farmers. Another experimental scheme for cotton, covering 909 farmers, was operated during
1978–79 in Gujarat, Madhya Pradesh and Maharashtra. These loss-making schemes led to the
realization that schemes based on individuals were not practical on a national scale.

The Pilot Crop Insurance Scheme

Following Prof. Dandekar‘s suggestion, GIC prepared a crop insurance scheme based on
the area approach and put it into operation from 1979–80. Initially, it was introduced as a pilot
scheme in three States and was extended to twelve States by 1984–85. Participation was
voluntary. The insurance premium ranged from 5–10 per cent of the sum insured. The number of
farmers covered in a year ranged from 16,000 to 60,000, except for 1984–85, when 4, 47,000
were covered. The loss ratio was 1.10 over the five-year period from 1979–80 to 1980–84. The
scheme was discontinued in 1985, when CCIS was introduced.

The Comprehensive Crop Insurance Scheme (CCIS)

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 The Government of India introduced CCIS in the financial year 1985–86. Operated by
GIC in collaboration with the respective State governments, the scheme covered cereals, pulses
and oilseeds. Crop insurance was linked to institutional credit; farmers who availed themselves
of loans for specified crops were eligible for insurance coverage. State governments were left to
decide whether to operate the scheme in the State or not. Once it was operational, participation
of farmers taking out short-term crop loans from credit institutions was compulsory. The
indemnity and premium were shared by the Central and the State governments in the ratio of 2:1.
Originally, the farmer was insured for 150 per cent of the loan disbursed to him for growing the
insured crops; this was reduced to 100 percent in 1988. The rate of premium was uniform for the
whole country: 2 per cent of the sum insured for rice, wheat and millet crops, and 1 per cent for
pulses and oilseeds. Even the low rate of premium was subsidized by 50 per cent in the case of
small and marginal farmers. This is in contrast of the rate of 5–10 per cent in the pilot crop
insurance scheme. The latter was voluntary, whereas CCIS was compulsory.

The scheme was based on the area approach. Area units called ―defined areas‖ were identified
for the purpose of assessing the indemnity. A defined area could be a district, a taluka, a block or
any other contiguous area. The actual average yield per hectare of the defined area was
determined on the basis of crop-cutting experiments. If the actual yield of an insured crop would
fall short of the specified TY, for the area, all insured farmers growing that crop in that area
would be deemed to have suffered the shortfall in the respective yield and entitled to receive the
indemnity.

The National Agricultural Insurance Scheme (NAIS)

After NAIS was introduced in Rabi 1999–2000, leading to the discontinuation of CCIS.
Like CCIS, NAIS is primarily based on the area approach. It covers all farmers: loanees and non-
loanees. It envisages coverage of cereals, millets, pulses, oilseeds and annual
horticultural/commercial crops for which adequate yield data are available.

Salient features of NAIS:

States and areas covered: All States and Union Territories had the option of implementing the
scheme.

Farmers covered: All farmers including sharecroppers and tenant farmers growing the notified
crops in the notified areas were eligible for coverage. The scheme was compulsory for farmers

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availing crop loans and voluntary for others.

Crops covered: Food crops (cereals, millets and pulses) Oilseeds Annual commercial /
horticultural crops (sugarcane, cotton, potato, onion, chilli, turmeric, ginger, jute, tapioca, annual
banana and annual pineapple)

Sum insured: The minimum sum insured (SI) in case of loanee farmers is the amount of loan
availed, which can be further extended up to value of 150 per cent of average yield. For non-
loanee farmer, it can be up to value of 150 per cent of average yield.

Premium rates: The premium rates are 3.5 per cent for oilseeds and bajra and 2.5 per cent for
cereals, millets and pulses during Kharif; 1.5 per cent for wheat and 2 per cent for other food
crops and oilseeds during Rabi. The rates for annual commercial/horticultural crops are based on
actuals.

Premium subsidy: Premiums for small/marginal farmers are subsidized to the extent of 50 per
cent, to be shared equally between the Centre and States. The premium subsidy was to be phased
out over a five-year period on sunset basis, starting with 50 per cent subsidy in the first year,
which would be reduced by 10 per cent each year and was to be completely phased out in five
years. However, 10 per cent subsidy continued to be given till the end.

Scheme approach: The scheme covered losses from sowing to harvesting, and operated on area
approach for widespread calamities. For this purpose, a unit of insurance is defined which may
be a Village Panchayat, Mandal, Hobli, Circle, Phirka, Block, Taluka, etc., to be decided by the
State Government /UT. However, each participating State government/UT was required to reach
the level of village panchayat as the unit within three years. The Scheme operated on an
individual basis for specific localized calamities on an experimental basis.

Sharing of risk: Government of India and States shared claims beyond 100 per cent of premium
for food crops and oilseeds on a 50:50 basis. In case of annual commercial / horticultural crops,
claims beyond 150 per cent of premium in the first three or five years and beyond 200 per cent
thereafter was borne by Centre and State on 50:50 basis.

Weather Based Crop Insurance Scheme (WBCIS)

The basic approach of ―weather index‖ insurance is to estimate the percentage deviation
in crop output due to adverse deviations in weather conditions. There are crop models and
statistical techniques available to work out the correlation between crop output and weather

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parameters. These techniques attempt to indicate the linkage between the financial losses
suffered due to adverse weather variations and also estimate payouts.

Features of WBCIS

1. WBCIS envisages such weather index-based insurance products designed to offer insurance
protection against losses to crop resulting from adverse weather Piloted in the Kharif 2007
season.

2. WBCIS also operates on the concept of area approach. For loss estimation, a Reference Unit
Area (RUA) is deemed to be a homogenous area unit of insurance. Each RUA is linked to a
Reference Weather Station (RWS);

Determinants of compensations in WBCIS

In WBCIS, claims are determined on the basis of weather data recorded by the RWS. Adverse
weather events during the season entitle the insured to a pay-out, subject to the weather triggers
defined in the ―Payout Structure‖ and the terms and conditions of the scheme. The claim
settlement is an automatic process, based on the weather readings at the RWS. In a given RUA,
the payout given per unit area is the same for all cultivators under the same RWS. Claims are
normally settled within 45 days from the end of the insurance period. Insurance companies
declare a per-unit Sum Insured at the beginning of each crop season in consultation with experts.
This may vary from crop to crop in each RUA. The sum insured for the loanee farmer is
calculated by multiplying per unit area value of inputs with crop specific acreage declared by the
farmer in the loan application form submitted to the lending bank. For a non-loanee farmer, the
acreage figure is expected area sown/planted under the particular crop as declared in the
insurance proposal form. Amount of insurance protection (sum insured) is broadly the cost of
inputs expected to be incurred by the insured in raising the crop. Sum insured is predeclared per
unit area (Hectare) by AIC at the beginning of every crop season, in consultation with experts in
State Government; and it may be different for different crops in different RUAs. Sum insured is
further distributed under the key weather parameters used in the insurance in proportion to the
relative importance of the weather parameters.

Premium rates depend on the ‘expected loss’, which in turn depends on the patterns of
weather parameters of historical period of about 25 to 100 years in the context of ideal weather
requirements of a crop. In other words, the premium rate could vary with each RUA and with
each Crop. However, the premium rates are capped for the cultivator; and the premium (rates)

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beyond the cap are shared by the Central and concerned State government on 50:50 basis.

Insured cultivators would become eligible for payout if the “Actual Weather” Data
recorded at a “Reference Weather Station (RWS)” during the specified time period shows
deviation (Adverse Weather Incidence) as compared to the specified “Trigger Weather”. In such
case, the specified ‘crop’ in that particular RUA shall be deemed to have suffered the same level
of Adverse Weather Incidence, and consequently the same proportion of loss of crop yield, and
become eligible for same proportion of Payouts.

National Crop Insurance Programme (NCIP)

As mentioned earlier, the Government of India has discontinued NAIS from Rabi 2013–
14, with the exception of a few States for one season only, and launched NCIP from November
2013. In the new programme, WBCIS, MNAIS and Coconut Palm Insurance Scheme (CPIS) are
included as full-fledged schemes with certain modifications over their pilots. Farmers are
entitled to maximum premium subsidy up to 50 per cent under WBCIS and 75 per cent under
MNAIS on a graded scale. Premium rates have been capped according to the type of crop and
season, and in cases where the actuarial premium rates are higher than the capped limit, the sum
insured for such crops will be reduced in proportion to the cap level. The Ministry of
Agriculture, GoI, has also issued operational guidelines for the scheme

2. Livestock Insurance

The Livestock Insurance Scheme, a centrally sponsored scheme, which was implemented
on a pilot basis during 2005-06 and 2006-07 of the 10th Five Year Plan and 2007-08 of the 11th
Five Year Plan in 100 selected districts. The scheme is being implemented on a regular basis
from 2008-09 in 100 newly selected districts of the country. Under the scheme, the crossbred
and high yielding cattle and buffaloes are being insured at maximum of their current market
price. The premium of the insurance is subsidized to the tune of 50%. The entire cost of the
subsidy is being borne by the Central Government. The benefit of subsidy is being provided to a
maximum of 2 animals per beneficiary for a policy of maximum of three years. The scheme is
being implemented in all states except Goa through the State Livestock Development Boards of
respective states. The scheme is proposed to be extended to 100 old districts covered during pilot
period and more species of livestock including indigenous cattle, yak & mithun.

The Livestock Insurance Scheme has been formulated with the twin objective of
providing protection mechanizm to the farmers and cattle rearers against any eventual loss of
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their animals due to death and to demonstrate the benefit of the insurance of livestock to the
people and popularize it with the ultimate goal of attaining qualitative improvement in livestock
and their products.

Department of Animal Husbandry, Dairying & Fisheries is implementing the Centrally

Sponsored Scheme of National Project for Cattle and Buffalo Breeding (NPCBB) with the
objective of bringing about genetic up-gradation of cattle and buffaloes by artificial insemination
as well as acquisition of proven indigenous animals. NPCBB is implemented through State
Implementing Agencies (SIAs) like State Livestock Development Boards. In order to bring
about synergy between NPCBB and Livestock Insurance, the latter scheme will also be
implemented through the SIAs. Almost all the states have opted for NPCBB. In states which are
not implementing NPCBB or where there are no SIAs, the livestock insurance scheme will be
implemented through the State Animal Husbandry Departments

3. Machinery Insurance.

This policy provides protection to your all-important farming companions such as

tractors harvesters, reapers, threshers, chaff cutters, salvage corps vehicle, Lawn movers etc, in
addition to the personal accident cover to you and your other family members who may use the
vehicle. This Policy is designed to cover the compulsory Third Party Liability as required by
Motor Vehicles Act, together with loss or damage to the Vehicle itself. The Policy also provides
cover for:

• Personal Accident for Paid Driver/cleaner.

• For an additional Premium, provides the following:
• Additional Legal Liabilities towards Paid Driver and employee.
• Bi-fuel Kit.
• Enhanced PA cover to Owner Driver and Paid Driver.
• No Claim Bonus Protection.
• Return to Invoice.

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 Lecture No 15.
Resource Economics: Concepts, Classification, differences between Natural Resource
Economics (NRE) and Agricultural Economics, unique properties of Natural resources.
Natural resource economics deals with the supply, demand, and allocation of the Earth's
natural resources. One main objective of natural resource economics is to better understand the
role of natural resources in the economy in order to develop more sustainable methods of
managing those resources and to ensure their availability to future generations. Resource
economists study interactions between economic and natural systems, with the goal of
developing a sustainable and efficient economy.
Natural resource economics is a trans-disciplinary field of academic research within
economics that aims to address the connections and interdependence between human economies
and natural ecosystems. Its focus is how to operate an economy within the ecological constraints
of earth's natural resources. Resource economics brings together and connects different
disciplines within the natural and social sciences connected to broad areas of earth science,
human economics, and natural ecosystems. Economic models must be adapted to accommodate
the special features of natural resource inputs. The traditional curriculum of natural resource
economics emphasized fisheries models, forestry models, and minerals extraction models (i.e.
fish, trees, and ore). In recent years, however, other resources such as air, water, the global
climate, and "environmental resources" in general have become increasingly important to policy-
making.

Natural Resources- Classification

Natural resources are the crucial resources in an economy, which should be treated in a holistic
manner to achieve several benefits. Natural resources could refer to all the living and nonliving
endowment of the earth. In common parlance, it denotes naturally occurring resources and
systems that are useful to human beings under plausible technological, economic, and social
circumstances. Natural resources are those resources that are not man made, including all the
earth’s natural elements and environmental forces.

According to Howe (1979), natural resources comprise of agricultural land; forest land and its
multiple products and services; natural land areas preserved for aesthetic, recreational or
scientific purposes; the fresh and salt water fisheries; mineral resources that include the mineral
fuels and non-fuels; the renewable non-mineral energy sources of solar, tidal, wind, and
geothermal systems; water resources; and the waste-assimilative capacities of all parts of the
environment. The objective of natural resource management is to bring about economically

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productive, socially equitable and environmentally sustainable uses of such resources. Therefore,
it is clear that what one perceives as natural resource depend on what the society inherited from
the past, the present and future technologies, economic conditions and tastes.

Generally, natural resources fall into four categories: (I) basic natural resources such as land,
water and air, (ii) natural resource commodities such as timber and fish, (iii) environmental
amenities such as clean air and scenic views and (iv) environmental processes such as pollution,
soil erosion, ground water recharge, and species regeneration.

Natural resources are also categorized based on the stage of development:

Potential Resources are known to exist and may be used in the future. For example,
petroleum may exist in many parts of India and Kuwait that have sedimentary rocks, but until the
time it is actually drilled out and put into use, it remains a potential resource.

Actual resources are those that have been surveyed, their quantity and quality determined, and
are being used in present times. For example, petroleum and natural gas is actively being
obtained from the Mumbai High Fields. That part of the actual resource that can be developed
profitably with available technology is called a reserve resource, while that part that cannot be
developed profitably because of lack of technology is called a stock resource
Attributes or dimensions of natural resources

A natural resource is multi attribute in nature with different dimensions. A natural resource can
be viewed in the following dimensions.

(1) Quantity: The availability of a natural resource may be infinite or finite in quantity and the
relative scarcity with respect to its end use decides its importance

(2) Quality: A resource may be available with different quality in nature. (e.g) Recovery of iron
from iron ore will be high or low depending upon the quality of ore excavated from different
parts of the world.

(3) Time: Natural resources are having time dimension and it refers to relative abundance or
scarcity of resources at different point of time. (e.g) A country becomes rich in resources by
discovering new resources or by finding new uses for already known resources.

(4) Space: There is variation in the endowment of natural resources across region and round the
world, but the demand for such resources is more or less uniform.

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 Natural resource supplies must be accounted both in terms of the stocks and flows. They
exist as stock or inventories or reserves at a point of time. It can also be viewed as a flow of
useful natural resource commodities or services which are produced from these stocks. The
stocks or reserves indicate what is known to be available for future use, while the flow of
commodities and services from the stocks indicate the level of current use. Some natural
resource stocks are renewable by natural or human assisted processes while some other stocks
are non-renewable. For example, solar, wind, and tidal energy, farmland, forests, fisheries, air,
and surface water represent renewable resources, while mineral ores and fossil fuels stand for the
non-renewable resources. Renewability often depends on appropriate and non-destructive
methods of management of resources like farmlands, fisheries, and also the on waste disposal,
since changes in some natural resource systems are irreversible.

The stock of a resource at a moment depends on available technology, costs, and social
constraints. Aluminium contained in ores other than bauxite is not a useful resource until the
needed recovery technology is developed. The production of many minerals from seawater is
feasible but is currently ruled out by high costs in most cases. While assessing the natural
resource stocks, the interactions between different sub systems and potential irreversible changes
must be taken into account. When coal is strip mined, flows of groundwater may be interrupted
and streams and wells may permanently go dry. Acid rain from sulphur may spoil water supplies
and kill plants and fish. Thus natural resources must be looked on as parts of larger systems.

Importance of natural resources

Natural resources are directly consumed as in the case of fresh fish, water, outdoor
recreation, and firewood; It may also be used as inputs in the intermediate processing such as
iron or copper ores into smelting; It also have consumptive uses in intermediate processing such
as consumption of fuels in manufacturing and transport; It is also having existence value or in
situ uses like free-running rivers, parks, and wilderness areas with its rich flora and fauna. In
some cases, these modes of utilization can be combined into multi-purpose natural resource
systems that utilize resources simultaneously to satisfy several needs. For example, the
management of forest lands to produce timber, to act as a watershed and to provide recreation.

Resource depletion

Resource depletion is an economic term referring to the exhaustion of raw materials within a
region. Resource depletion is most commonly used in reference to farming, fishing, mining, and

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fossil fuels.

Causes of resource depletion

1. Over-consumption/excessive or unnecessary use of resources
2. Non-equitable distribution of resources
3. Overpopulation
4. Slash and burn agricultural practices, currently occurring in many developing countries
5. Technological and industrial development
6. Erosion
7. Irrigation
8. Mining for oil and minerals
9. Aquifer depletion
10. Forestry
11. Pollution or contamination of resources

Major issues in use of natural resources – productivity, equity &sustainability

Resource productivity is the quantity of good or service (outcome) that is obtained
through the expenditure of unit resource. This can be expressed in monetary terms as the
monetary yield per unit resource. Resource productivity and resource intensity are key concepts
used in sustainability measurement. The sustainability objective is to maximize resource
productivity while minimizing resource intensity

Equity and issues in equity of natural resources

Equity derives from a concept of social justice. It represents a belief that there are some
things which people should have, that there are basic needs that should be fulfilled, and that
policy should be directed with impartiality, fairness and justice towards these ends .Equity
means that there should be a minimum level of income and environmental quality below which
nobody falls.
Intra-generational equity
Equity can also be applied across communities and nations within one generation.
The reason that intra-generational equity is a key principle of sustainable development is that
inequities are a cause of environmental degradation. Poverty deprives people of the choice
about whether or not to be environmentally sound in their activities.
Equity issues, key parameters and indicators:
Key parameters and indicators
First, the majority of people would be deprived in terms of low welfare level despite their hard
work (equity failure),
Second, unfair access to public infrastructure, facilities and services could occur (equity
failure). i.e . Failure to guarantee intra- and inter-generational equity would cause deep
inequality and un sustainability
Third, natural resources may be so exploited that threaten their sustainability of use.
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 Fourth, negative externalities of economic activities could create serious threat to the
environment
Equity issues: Nine Equity Issues are
1. Income and employment system
2. Access to facilities and services
3. Access to natural resources
4. Fairness in competition
5. Natural resource exploitation
6. Negative externalities
7. Non-production function
8. Compensation to worse-off people
9. Sustainability reinvestment
Sustainability is the capacity to endure. In ecology, sustainability describes how biological
systems remain diverse and productive over time, a necessary precondition for human wellbeing.
Long-lived and healthy wetlands and forests are examples of sustainable biological systems.

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 Lecture No. 16.
Natural Resource Issues – Scarcity of resources – Factors mitigating Scarcity, Property
Rights – Common Property Resources (CPR’s): meaning and Characteristics of CPRs –
Externalities: Meaning and Types – positive and negative externalities in Agriculture
Natural Resource Issues

1. The major question confronting the world at present is ‘How long and under what conditions
can human life continue on earth with finite stocks of in situ resources, renewable but
destructible resources, population, and limited environmental systems?’ It is crystal clear that
vital resource stocks such as mineral and fuels are finite and the rates of consumption of such
stocks have accelerated in recent decades far beyond all historical rates. Some major renewable
resource systems like marine fisheries and groundwater systems are exploited indiscriminately,
there by environmental capacities are exceeded in serious proportion. There is an urgent need to
optimize natural resource use with sustainability.

2. Second major issue is the location of known reserves. World petroleum reserves are huge and
more is being discovered day by day. But these reserves are not located in the major consuming
countries of the West. The same is true with bauxite, iron ore, chromium, and natural gas. What
does this imply for the vulnerability of consuming countries to political pressures and exorbitant
price increases by OPEC group?

3. Third issue is the historical shift from the use of renewable resources to the nonrenewable
resources. For example, coal became important when charcoal supplies became increasingly
costly, both in terms of proximity of forests and in terms of undesirable environmental effects. In
most parts of the world, agriculture has shifted from natural fertilizers to those synthesized from
natural gas. Consumer durables and commercial packaging shifted from patterns of reuse and
repair to throwaway strategies. As non-renewable natural resource stocks dwindle, can these
patterns be reversed or not? has to be answered.

4. Fourth issue of concern is the contemporary evolution of the wisdom of past patterns of
resource utilization. There are examples of unwise, short sighted, rapacious exploitation of
natural resource systems along with their related social systems.

5. Fifth issue closely related to whether one had correct understanding about the role and
importance of natural resource and environmental service as factors in the past economic growth
endeavor. Most analyses of the causes of economic growth have placed great emphasis on the
growth of technology and improvement of human capital, but few have adequately examined the

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role of raw material inputs and the increasing use of the environment for waste disposal. It
appears possible that these inputs may have been more important than suspected and may not be
freely available in the future.

6. Sixth issue is the growing dependence on increasingly inferior reserves of natural resources. In
the cases of many resource stocks, one finds a continuous spectrum of quality and quantity,
implying greater reserves at the cost of exploiting poorer ores. Seawater contains incredible
stores of minerals, but the energy requirements for recovery are, in most cases, prohibitive. Will
energy availability permit the exploitation of these resources or shall we have to we forget them
as usable reserves? And then, what environmental consequences may arise from exploiting such
resources. How is it possible to continue exploiting more diffuse resources without defiling our
environment? Is it possible to avoid major changes in ecosystems as we push back the margins
of agricultural land use, forest harvesting, fishing, and water development?

7. Seventh issue closely related to the previous two issues and it revolves around the evolution of
limiting global environmental conditions. The most widely discussed is accumulation of carbon
dioxide in the upper atmosphere, resulting from the combustion of fossil fuel and deforestation.
This may trigger perceptible changes in earth’s temperature and climate. If science determines
that it does, restrictions may be imposed on economic activities

8. Eighth issue is the role of market processes in determining how resources will be managed /
used over time. Markets play an important role in determining exploration activity and rates of
use. It has been convincingly demonstrated that changing relative prices has largely induced
technological innovation.

Scarcity of Resources

Any commodity having a positive price in the competitive market is said to be scarce.

Fisher (1978) suggests that an ideal index of scarcity should measure and include the direct and
indirect sacrifices gone into the commodity. It comprises of (1) the price of a natural resource
commodity, (2) the rental or royalty payment made for land containing resources, (3) the costs of
physical extraction (not including royalty payments), and (4) the rate at which capital and labour
can be substituted for natural resource inputs and the respective opportunity costs.

Factors Mitigating Scarcity

How come a rapidly developing nation with strong economic and population growth in the

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present world, not facing greater scarcity of natural resource? Many factors have been at work in
mitigating the scarcity and some are listed below.
1. Technological Changes: Technology may be of different kinds and they may be a.
Technologies which increase the efficiency of resources use. Eg technologies meant for greater
smelting recovery of metals from ores and finer woodworking techniques to save wood.
b. Technologies which increase the natural resource recovery both by leaving less in situ and
also facilitating the use of lower grades Eg., tertiary petroleum recovery, long wall coal mining,
pelletising of taconite iron ores.
c. Technologies that permit use of formerly unusable or latent resources Eg., recovery of
aluminium from non bauxite sources.
d. Technologies that permit new products to perform old functions or to fulfil needs Eg., Solid
state electronic boards for vacuum tube systems and communication conference networking for
personal travel.
2. Substitution of More Plentiful Resources for Less Plentiful

a. Substitutions in production processes Eg., Aluminium for copper, pre-stressed concrete for
structural steel and biocides for organo - mercurials..
b. Substitutions in consumption Eg., grains for meat, artificial fibres for natural fibres, and
plastics for leather.
3. Trade: Improvements in transport facilities could make more remote resources economically
competitive. Utilization of international sources is possible because of trade links between
countries Eg., bauxite from Jamaica, iron ore from Liberia.

4. Discovery: Extension of traditional exploration methods for discovery of new deposits and
improvements in exploration techniques may help in adding resources to the existing stock Eg.,
improvements in geophysical and geochemical methods and satellite reconnaissance.

5. Recycling: Recycling of used resources for further use is a very important option in mitigating
resource scarcity Recycling is the order of the day in United States and the percentages of
recycled materials derived from scrap in the case of iron is 37 percent; like wise for lead it is 37
percent; copper, 20 percent; aluminium, 10 percent; nickel, 35 percent; and antimony 60 percent.

6. Judicious management of Natural Resources: Existing resources should be used judiciously

according to the need and it should also be conserved to ensure continuous flow of benefits.
There should be optimum utilization of resources not only for short period but also for sustained
long period. The following principles have been evolved to conserve resources.

a) Economic use of resources to achieve minimum waste

b) Sustained use of economic resources through conservation of renewable resources and
economic use of exhaustible resources.
c) Encouraging multipurpose use of resources
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d) Integrated planning in use of natural resources.
e) Minimizing transport cost by locating industries nearer to source of raw material.
f) Optimum utilization of electrical power and other resources
Property rights

Property rights are theoretical constructs in economics for determining how a resource is
used and owned. Resources can be owned (the subject of property) by individuals, associations
or governments. Property rights can be viewed as an attribute of an economic good. This
attribute has four broad components and is often referred to as a bundle of rights and these are

1. The right to use the good

2. The right to earn income from the good
3. The right to transfer the good to others
4. The right to enforcement of property rights.
In economics, property usually refers to ownership (rights to the proceeds of output generated)
and control over a resource or good.

Common Property Resources

Common Property Resources (CPR) are those properties owned in common by

identifiable group of people. They are widely prevalent in India especially in semi-arid and arid
regions, hill regions, forest and tribal regions. In semi-arid and arid regions, the area under CPRs
is very low but closely integrated with well-defined institutional setup. In hill regions, the use of
CPR is high but ownership rights are defined not clearly while in forest tribal regions, the use of
CPR is variable. The majority of area under CPR comes under open forests, surface ground
water and fisheries. The CPRs occupy a quite significant area under non-forest lands with 38 per
cent, ground water with 44 per cent, fresh water ponds and tank fisheries with 80 per cent.

A Common Property Resources (CPRs) is a resource owned by a large group of individuals

whose access to the resource can be limited or unlimited. Eg. forests, ocean fisheries etc., Most
of the CPRs have the properties of renewable resources. These resources have the capacity to
renew or regenerate themselves.

Characteristics of CPRs

CPRs have some significant characteristics, which distinguish from Private Property
Resources (PPRs) or State Property Resources (SPRs) or Open Access Resources (OPRs).
Firstly, improperly defined individual private property rights, which lead, to the usage of the
resource characterize it by more number of individuals as against the capacity of the resource

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system to sustain. Secondly, the CPRs are characterized by joint use among the members of the
community. Whenever, resources are used jointly, members try to maximize their marginal
private benefits and minimize their marginal private cost as against socially optimum benefits or
costs.

Market Failures
Three conditions under which free or incomplete markets fails to achieve efficient
resource use.
1. The market is not purely competitive
2. The resource is a common property or open access resource
3. There are externalities
Each one of these conditions constitute a market failure. Prices generated in the market do not
provide firms and households with the incentives needed to achieve socially efficient resource
use.

Externalities

An externality exists when the activities of acting party influence the welfare of an
affected party and the acting party does not consider how its activities affect welfare of the
affected party. This takes place between firms, between households and between households and
firms. If the acting party engages in an activity for benefiting or harming the affected party, then
it is not an externality.

Types of externalities

Two types of externalities are pecuniary externality and technological externality and the
latter adversely affects economic efficiency.

Pecuniary when company developed software package that reduces time for electronic
communication. Other firms doing business with the company get benefit from time savings but
do not bear cost of developing software. This externality changes only relative prices and
financial condition faced by affected parties, it does not result inefficient use of resource.

Technological affects level of production or satisfaction achieved by affected party, which

results inefficient resource use. E.g. Core family playing loudspeaker.

2 types External economies (increases welfare of affected party) and external diseconomies
(decreases welfare of affected party).

Activity generating externality external to affected party-external. Because of negative welfare

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effects, external diseconomies are of great concern than external economies.

Externalities classified according to whether there is conflict between acting and affected parties
and whether they cause inefficient resource use which is given in Table.

Classification of Externalities

Types of Externality External economy External diseconomy

Technological No conflict Conflict
Inefficiency Inefficiency
Pecuniary No conflict No conflict
No inefficiency No inefficiency
Positive and Negative externalities in Agriculture

An example for positive externality in agriculture is farm production increased by doing

apiculture of the nearest farm or by the same farm.

An example for the negative externality in agriculture is production in textile industry

which creates polluted water and passes through the irrigation canal affects the production and
quality of farm products.

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 Lecture No. 17.
Inefficiency and welfare loss, solutions, Important Issues in Economics and management of
Common Property Resources of land, water, pasture and forest resources
Inefficiency and welfare loss

All environmental and natural resource problems associated with overexploitation or

under provision of public goods, arise from incompletely defined and enforced property rights,
whether they be informal or formal, group or individual. Under these circumstances, private
decision makers do not consider or internalise social benefits and costs in their production or
investment actions. The gap between private and social net returns results in externalities –
harmful effects on third parties. These include overfishing that depletes the aggregate stock,
excessive air pollution that reduces overall air quality, unwarranted extraction or diversion of
ground or surface water that diminishes supplies, extreme depletion of oil and gas reservoirs that
lowers overall production and raises costs, as well as too little private investment in natural
amenities and biodiversity.

These situations are all examples of the ‘The Tragedy of the Commons. The tragedy occurs
through aggregate short‐term production or use levels that are too high and long‐term investment
in the stock that is too low. Competitors for resource rents inflict costly technological and
pecuniary externalities on one another. Anticipation of these spillovers generates a damaging
rush to exploit the resource. Compounding the tragedy, in the absence of recognised property
rights exchange is not possible. The parties involved cannot bargain with one another in the
manner described by Coase (1960) to constrain behaviour to limit dissipation and to re‐allocate
the resource to higher‐valued uses currently or across time. Free riding is rampant. As a result,
there can be no price signals to reveal opportunity costs, underwriting wasteful use decisions that
are made in ignorance of such information. Finally, the tragedy is accentuated by the diversion
of valuable labour and capital inputs from productive use to predation and defence. Damaging
conflict and violence may follow.

The wastes associated with the common pool resources can be large, and the social savings from
avoiding them provide the incentives for collective action (i) to develop informal property rights
(individual or group) or if these are not feasible, (ii) to secure more official government
regulation of access and resource use or (iii) to assign formal property rights for private
restrictions on behaviour.

Solutions

Considering each of these options in turn, the first, group solutions or common property,

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can be effective if the parties involved are relatively homogeneous in costs, discount rates and
production objectives, and if their numbers are comparatively small.6 Under these conditions,
cooperative internal rules can be agreed upon and put into place to manage the resource or to
provide group goods.

Exogenous factors, such as price increases or new production technologies, however, can make
common property less effective. The incentives for defection among the existing group members
rise, and new, more heterogeneous entrants are attracted, who are not part of the original
compact, and hence have less incentive to adhere to its constraints. These conditions lead
localised arrangements to collapse, especially if they do not receive recognition and enforcement
from the state, which they may not if group members are not as politically influential as are the
new entrants.

The second option, government regulation, involves constraints on inputs or outputs to bring
production in line with more optimal levels and/or tax schemes to bring private and social use
costs into closer alignment. Although central (command and control) regulation and taxes can
eliminate externalities and hence, the ‘Tragedy of the Commons,’ the empirical history in many
cases has not been particularly satisfying.

Effective regulation and taxes require that politicians and regulators have information not only
about social costs and optimal levels of production, but also about the (often varying) private
production and compliance costs of individual users. This is a requirement that few regulators
can meet. As a result, government regulation typically relies upon uniform standards, including
standardised controls on access, fixed tax levels, and similar constraints on timing of use and/or
limits on technology or production capital. Uniformity reduces information demands and makes
regulation appear to be equitable, making it more politically attractive.

Uniform regulations and taxes, however, do not reflect differences in production or compliance
costs. Accordingly, centralised rules are unlikely to align with the incentives of actual users of
the resource. Rather, the motives of the regulated or taxed parties are for evasion, raising
enforcement costs. Under regulation and tax policies, users, by definition, are not ‘owners’ and
hence, typically do not capture the increased social returns from protecting or investing in the
stock through conservation. As such, they rationally maximise private returns through cheating.
The setting becomes one of agents against the state, and the resource suffers.

Finally, and critically, the decisions by all parties, regulators in implementing policies, and
actual users in harvesting, extracting and emitting, take place in the absence of information about

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the value of alternative resource uses (opportunity costs) that market trades otherwise would
generate. This condition results in wasteful misallocation.

Overall, government regulation and tax policies suffer from a variety of well‐known problems
including high cost, inflexibility, ineffectiveness and industry capture. Generally, no party
involved – actual users, regulators, politicians – is a residual claimant to the social gains from
more optimal resource management and use. Accordingly, extraction, production, investment
and allocation decisions are based on other factors that are apt not to be consistent with
maximising the economic value of the resource or of conserving it. Often, the amounts at stake
in implementing regulatory and tax policies are large, encouraging costly rent seeking as parties
attempt to mould government actions in their behalf.

Common property resource management

Common property resource management involves costs and benefits. The cost benefits
affect resource management. They vary according to the temporal, spatial, tangibility, and
distribution dimensions. The local institutions will be most effective in management if the
benefits of Resource management accrue quickly, locally, visibly, and individually or
collectively. The opposite is true if the benefits are delayed, remote, hard to identify and do not
accrue to the investors of efforts.

The management of the natural resources also depends upon the characteristics of resources. The
less renewable a resource is the more risk there is that poor management will have drastic
consequences, and the more reason one can offer for some form of government involvement.
Seasonality is another factor of great importance for resource management. Examples from
Botswana, Philippines, Indonesia, and Nepal suggest that the flow of local institutional activity is
generally affected by variations in the agricultural season. During wet season, water is abundant
and it needs less co-operative efforts for water management and maintenance. As a result, local
institutions are less active and united for its management. During the dry seasons, water is
scarce, local user groups cannot work effectively and central government's intervention is almost
inevitable. Similarly, during the rainy season fodders are abundant in private lands and forest
resources need less management attention, while fodders are scarce during the winter resulting in
efficient management and distribution of fodder trees among the communities (Acharya 1990).

More importantly, property arrangement is an effective mechanism of resource management.

There are numerous examples of communities who preferred to keep and use common property
resources jointly. For example, the Rais, Limbu, Sherpa. Chepang, Lapcha, Majhis, Tamangs,

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Sunuwar, and Danuwar communities of Nepal owned and controlled their natural resources, such
as forests and lands jointly and they are distributed in accordance with the family requirements
(Regmi, 1971). Because the domestic units held individual rights to use resources not ownership,
resource alienation was impossible. This system of property rights protected natural resources
from fragmentation resulting in degradation.

Land Resources

Common property land resource refers to lands identified with a specific type of property rights.
The common lands covered in the National Sample Survey (NSS) enquiry are panchayat lands,
government revenue lands, village common lands, village thrashing lands, unclassified forest
lands, woodlands and wastelands, river banks, and lands belonging to other households used as
commons.

Forest & Pasture Resources

Common property resources, particularly forests and pastures are rapidly decreasing and
deteriorating in developing countries like Nepal resulting in many unintended and unanticipated
environmental problems. Unclassified forests, with very low productivity, are always open to use
by local communities: Accordingly, both protected and unclassified forests are treated as
forming a part of common property forest resources. It is, therefore, the subset of total forest area
minus reserve forests to which common property rights are assumed to exist.

Water Resources

There are a variety of resources of water, which are in the public domain, and a significant part
of these are included in the category of commons. Examples are flows of rivers, tanks and
natural lakes, groundwater, wetland and mangrove areas, and such other water bodies. Man-
made water resources such as dams and canals, tube wells, other wells, and supply of all types of
potable water also fall in the category of CPRs depending upon their property rights.
Unfortunately, even after many debates about property rights (such as traditional rights,
community rights, and basic need human rights), water has not yet been declared as CPR in
India, though references are made in the water policy document indirectly. By and large, water
resources in India are in common property regimes only. Irrigation canals are managed jointly by
the government and communities. Traditionally, tanks, village ponds, and lakes - all of which are
treated as CPRs -are sources of water for drinking, livestock rearing, washing, fishing and
bathing, and several sanitary-related activities.

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BASIC TERMS AND CONCEPTS USED IN AGRICULTURAL PRODUCTION
ECONOMICSAND FARM MANAGEMENT
1. FARM : It means a piece of land where crops and livestock enterprises are taken up
under a common management and has specific boundaries.
2. AGRICULTURAL HOLDING: The area of the land for cultivation as a single unit
held by an individual or joint family or more than one farmer on joint basis. The land may be
owned, taken on lease or may be partly owned and partly rented.
3. OPERATIONAL HOLDING: It refers to the total land area held under single
management for the purpose of cultivation. It excludes any land leased to another person.
4. UNITS OF ACCOUNTING: Application of inputs or measurement of output relate to
technical unit, plant or an economic unit.
a) TECHNICAL UNIT: Single, convenient unit in production for which technical
coefficients (input- output coefficients) are calculated. Examples are an acre, a hectare, a cow
etc.
b) PLANT: Generally refers to a group of technical units such as dairy enterprise or say 15
acre farm.
c) FARM FIRM : Aggregation of resources for which costs and returns ar e worked
out as a whole. Farm-firm is also known as economic unit. Example: a farm holding.
5. RESOURCES AND RESOURCE SERVICES :
Resources Resource services
1. Any commodity or goods used by the firms 1. A services is any act or
in production performance that one party can offer
2. Physical products (material) and tangible to another
3. Resources get consumed or 2.Neither material nor tangible.
physically enter the production process so as to 3.Only services are available which
be transformed into products. are transformed into products.
4. Resources being physical products can be 4. Services cannot be stored
stored. (Perishable).
5. plant protection chemicals, Ex: Seeds, manures, fertilizers, 5.Ex:
herbicides, irrigation water, feeds, veterinary Services of land,
medicines, fuel etc labour,
machinery, equipment, implements, livestock, farm buildings etc., Resources and resource
services are called factors of production. They are needed to produce any commodity.

6. FIXED RESOURCES:
a) The resources whose use remains the same regardless of the level of production are
called fixed resources.
b) Volume of output does not directly depend up on these resources.

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c) Costs corresponding to these resources are known as fixed costs.
d) Fixed resources exist only in the short run and in the long run they are
zero
Example: land, machinery, farm buildings , equipment, implement, livestock etc. ,
7. VARIABLE RESOURCES :
a) The resources whose use vary with the level of production are known as
variable resources.
b) Volume of output directly depends on these resources.
c) Costs corresponding to these resources are known as variable costs.
d) Variable resources exist both in the short run and in the long run.
Seeds, Fertilizers, Plant protection chemicals, FYM, feeds, medicines etc., are
examples of variable resources.
8.FLOW AND STOCK RESOURCES:
Flow Resources: There are some resources which should be used as and when they are
available. They cannot be stored or stocked for a future use. Services are forthcoming like a
flow. Examples are labour, Sunshine, land, farm buildings, machinery, equipment etc.
Stock Resources: The resources which are not used in one period of production can be
stored for a later period. Examples are seeds, fertilizers, feeds, manures, plant protection
chemicals etc. Some factors of production are both flow and stock services. Whether a
service should be defined as flow or stock depends on the length of the time period
under consideration.
Examples are land, machinery, buildings etc.
A building lasts for 50 years provides a flow of services in each of the individual years,
still it provides a stock of services for 50 years period. Similarly a tractor gives flow of
services for each year, but a stock service over 10 years.

9. PRODUCTION : It is a process whereby some goods and services called inputs are
transformed into other goods called output is known as production.
(Or)
Production is a process of transformation of certain resources (inputs) into products.

10. PRODUCT: It is the result of the use of resources. Product is any good or service that
comes out of the production process.

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11. TRANSFORMATION PERIOD (OR) PRODUCTION PERIOD :
The time required for a resource to be completely transformed into a product is
referred to as transformation period .
The production period varies with the type of resource. Some resources are transformed
into products in short time period (seeds, feed, fuel, fertilizers, manures, plant protection
chemicals etc.,). Others over a long period of time (machines, buildings etc) and still others
are never completely transformed (land). The variations in production period give rise to
complexities in decision making.
12. CHOICE INDICATOR:
It is a yardstick, or an index or a criterion indicating which of two or more alternatives
is optimum or will maximize a given end.
The choice indicator as a yardstick by which selection between
alternatives is made, indicates the relative value which is attached to one as compared to
another alternative.
Choice indicators can be applied to problems in physical production as well as to those
of profit maximization and consumer welfare. Choice indicators in economics are almost
always given as ratios: examples are substitution ratios and price ratios.

13. SHORT RUN AND LONG RUN: These are time concepts but they are not
defined as fixed periods of calendar time.
The short run is that period of time during which one or more of the
production inputs is fixed in amount and cannot be changed.
The level of production can be varied to a little extent by intensive use of fixed resources
or by using more amounts of variable resources. During the short period, demand and
supply change a little but not much.
For example, at the beginning of the planting season, it may be too late to increase or
decrease the amount of crop land owned or rented. The current crop production cycle
would be a short run period as land is fixed in amount.
The long run is defined as that period of time during which the quantity of all necessary
productive inputs can be changed.
The level of production can be varied to a greater extent by varying all the
factors of production. Demand and supply conditions have plenty of time to adjust
themselves.
In the long run, a business can expand by acquiring additional inputs or go out of existence
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by selling all inputs.
Depending on which input(s) are fixed, the short run may be anywhere
from several days to several years. One year or one crop or livestock production cycle are
common short run periods in agriculture.
The distinction between fixed and variable resources holds true only in the short run. In
the long run, all resources are variable .

14. COST OF CULTIVATION : It refers to the cost of various inputs and input services
used for raising a particular crop. It includes all the operations from land preparation to
threshing, cleaning and taking the product from the field to home. Cost of cultivation
always refers to unit area (acre or hectare).
15. COST OF PRODUCTION: It refers to the cost of various inputs and input
services used to produce a unit quantity of output of a commodity.
16. ECONOMY: It is a system which provides people with means to work and earn a
living. Economy consists of all sources of employment and production such as firms,
factories, workshops, mines etc.
17. ECONOMIC SYSTEM : It is an institutional framework within which society
carries the economic activities.

18. EFFICIENCY: it means absence of waste or using the economy’s resources as

effectively as possible to satisfy people’s needs and desir es.
19. TECHNIOCAL EFFICIENCY: It refers to the amount of output with given
amounts of factors of production. In other words, technical efficiency is the ratio of
output to input (Average physical product).
Technical efficiency = Y/X, Where Y= Total output and X= Quantity of input
20. ECONOMIC EFFICIENCY: It is a ratio of value of output to value of input.
Economic efficiency = Y.Py / X.Px
21. OPTIMUM : It is the ideal condition in which the costs are minimum and profits are
maximum.
22. MONOPERIOD RESOURCES: The resources which can be used in a single
production period are called mono period resources. Seeds, feeds, fuel, fertilizers, manures,
plant protection chemicals are some of the examples of mono period resources.
23. POLYPERIOD RESOURCES: The resources which provide their services for several
years in production are known as poly period resources. Examples are land, livestock,
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machinery, equipment, buildings etc.
24. ENTERPRISE: It is defined as a single crop or livestock commodity being produced on
a farm.
25. FARM ENTERPRENEUR: He is the person who thinks of, organizes and operates the
business and is responsible for the losses and gains from the business. He is a pioneer in
organizing and developing the farm firm.
26. FARM MANAGER: He is a person who manages or supervises the business according
to instructions of the entrepreneur. He is hired to manage the business. He is not
generally responsible for any gain or loss to the business.
27. PRODUCTION FUNCTION (PF):
It is the systematic way of showing the relationship between different amounts of inputs
that can be used to produce a product and the corresponding output of that product.
Definition : Production function is a technical and mathematical relationship describing the
manner and the extent to which a particular product depends upon the quantities of
inputs or input services, used at a given level of technology and in a given period of
time.
In short, the relationship between input and output is termed as production function.

Formulae
1. Production function: y = f (x1, x2, x 3,…..xN)
where y is output of a crop, x1, x2, x3,…..xN are inputs, f denotes function of
2. Linear production function y = a + bx
where y is dependent variable (output), a is constant, b is coefficient, x is
independent variable (input)
3. Cobb-douglas (non linear production function) y =axb
where y = dependent variable, a constant, b coefficient, x independent variable
4. Quadratic function y = a + bx – cx2
where y = output or yield dependent variable, a constant, c & b coefficient,
x input (independent variable)
Y1 Y2 Yi Yn
  ....   ... 
X 1 X 2 X i Xn
5. Law of increasing returns:
Y1 Y2 Yi Yn
6. Law of constant returns: = = .... = = ... = =k
X 1 X 2 X i Xn

7. Law of decreasing returns: Y11 Y12 Y1n

  ....... 
X 11 X 12 X 1n
8. Marginal physical product
change in output TPP Y
MPP= = =
change in input X X

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 Total output Y
9. Average products: APP = =
Quantity of input X
change in total value output TPP Y .Py
10. Marginal value product MVP = = =
change in input level X X

11. Marginal factor cost (MFC) or marginal input cost (MIC)

change in total input cost X Px
MIC = =
change in input level X

change in total revenue TR Y Py

12. Marginal Revenue (MR): MR = = =
change in output level Y Y
change in total cost X Px
13.Marginal cost (MC): MC = =
change in output level Y
14. Marginal rate of technical substitution (MRTS):
number of units of replaced resource X 2
MRTSX1 X 2 = =
number of unit of added resource X1
15. Marginal Rate of product substitution (MRPS):
number of units of replaced product Y2
1 2 =
MRPSYY =
mber of unit of added product Y1
price of added resource PX 1
16. price radio of factor: PR = =
t of added resource PX 2
price of added resource product PY1
17. price radio of product: PR = =
price of added product PY2
X 21 X 22 X 2 n
18. Decreasing rate of factor substitution=   .... 
X 11 X 12 X 1n
X 21 X 22 X 2 n
19. Increasing rate of factor substitution=   .... 
X 11 X 12 X 1n
X 21 X 22 X 2 n
20. Constant rate of factor substitution= = = .... =
X 11 X 12 X 1n
Y Y Y
21.Decreasing rate of product subsititution= 11  12  ....  1n
Y21 Y22 Y2 n
Y11 Y12 Y
22.Increasing rate of product subsititution=   ....  1n
Y21 Y22 Y2 n
Y11 Y12 Y
23.Constant rate of product subsititution= = = .... = 1n
Y21 Y22 Y2 n
23. Short run production function y = f (x 1 / x2, x 3 … … x n)
24. Long run production function y = f (x 1, x2, x3 …… xn)
25. Future value of present sum (compounding)=
FV = P (1 + i)n
FV: Future value; P: present sum (original investment); i : rate of interest;

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n : number of years.

26. Present value of Future sum (Discounting):

P
PV =
1in
where PV: Present value; P: sum to be received in future); i : rate of interest;
n : number of years.
27. Variable cost (TVC) = P x1 X1
Px1 = price per unti of X1, X1 = Quantity of X1 input
n
28. Total fixed cost (TFC) = (j = 2, 3, … w)
Px X j
y
j1
29. Total cost (TC) = Total variable cost + Total fixed cost
TC = TVC + TFC
Total variable cost
30. Average variable cost (AVC) =
output
TVC
AVC =
Y
Total fixed cost
31. Average fixed cost (AFC) =
output
TFC
AVC =
Y
32. Average total cost (ATC) =
Average total cost (ATC) = Average variable cost + Average fixed cost
ATC = AVC + ATC or
33. Cost A2 = Cost A1 + Rent on leased in land
34. Cost B = Cost A1 / A2 + Rent on owned land + Interest on owned fixed capital
35. Cost C = Cost B + Value of family labour
36. Farm business income = Gross income – Cost A1 / A2
37. Family labour income = Gross income – Cost B
38. Net income = Gross income – Cost C
39. Farm investment income = (Gross income – Cost C) + (Cost B – Cost A)
40. Net cash income = Total cash income – Total cash operating expenses
41. Net Farm income = Net cash income + Change in inventory and depreciation
42. Farm earning = Net farm income + Value of farm products consumed in home
43. Family labour earnings =Farm earnings – Interest on capital
44. Returns to management = Family labour earnings - Value of family labour

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 Operating expenses
45. Operating cost ration (OCR) =
Gross income
Total fixed costs
46. Fixed cost ratio (FCR) =
Gross income

47. Gross cost ratio (GCR) = Total costs

Gross income
Gross income
48. Rate of capital turnover =
Total capital invested
Total assets
49. Net capital ratio (NCR) =
Total liabilities
Current assets Working assets
50. Working ratio (WR) =
Current liabilities Working liabilities

51. Current ratio (CR) = Current assets

Current liabilities
Total liabilities
52. Debt/equity ratio =
Owner's equity or net wroth

53. Production efficiency =

x 100
Yield of a crop on the farm
Average yield of the same crop in the locality
Gross cropped area
54. Cropping intensity = x 100
Net sown area
55. Productive man work units per mar equivalent
Total productive man work units
Number of man equivalents
Original cost - Junk value
56. Straight line method =
Useful life
57. Diminishing balance method = (Book value at the beginning) x R
where R is rate of depreciation
58. Sum of the years digits method = (Original cost – Junk value) X
RL : Remaining years of useful life RL
SoYD : Sum of the years digits SoYD
59. Income capitalization V = R / r
where V = capitalized value, R = Net income per unit of land per annum, r = rate of
interest
60. Break -even output =Annual fixed cos/ (selling unit price – unit variable cost)

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ABBREVIATIONS
1. P F : Production Function
2. EP : Elasticity of production
3. SRPF : Short run production
4. LRPF : function
Long run production
5. TP : function
Total Product
6. MP : Marginal product
7. AP : Average Product
8. TPP : Total physical product
9. APP : Average physical product
10. MPP : Marginal physical product
11. TVP : Total value product
12. AVP : Average value product
13. MVP : Marginal value product
14. MFC : Marginal factor cost
15. MIC : Marginal input cost
16. MC : Marginal cost
17. MRS : Marginal rate of substitution
18. MRTS : Marginal rate of technical
19. MRPS : substitution
Marginal rate of product
20. PR : substitution
Price ratio
21. TFC : Total fixed cost
22. TVC : Total variable cost
23. TC : Total cost
24. AFC : Average fixed cost
25. AVC : Average variable cost
26. ATC : Average total cost
27. PPC : Production possibility curve
28. LCC : Least cost combination of
29. LDR : resources
Law of diminishing returns
30. LEMR : Law of equi-marginal
31. CYI : returns.
Crop yield index
32. CI : Cropping intensity
33. GI : Gross income
34. NI : Net income
35. PMWC : Productive man work unit
36. BEO : Break-even output
37. BEP : Break-even point
38. NCR : Net capital ratio
39. WR : Working ratio

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40. CR : Current ratio
41. MR : Marginal revenue
42. OCR : Operating cost ratio
43. FCR : Fixed cost ratio
44. GCR : Gross cost ratio
45. FBI : Farm business income
46. FLI : Family labour income
47. LP : Linear programming

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