Von der Embse, Barry J.

Zulauf, Carl R.

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ESO 1095 A GUIDE TO UNDERSTANDING FARM PRODUCTION COSTS Prepared by Carl Zulauf and Barry VonderEmbse* April 2, 1984 *Cnrl Zulauf is Assistant Professor of Agricultural Economics, The Ohio State UnivPrsity. Barry VonderEmhHL' is a current undergraduate student, The Ohio StaLL' University. The authors wish to thank Dick Duvick and Kathy Mattfeld for their assistance. Output Output Figur~ 1: The Productiun Fuuction and Cost Curves PHYSICAL PRODUCTION FUNCTION I I I I I I t c I Input I I I I I I I TPP - Total Physical Product AJ>p - Average Physical Product MPP - Marginal Physical Product $ (Cost of input) PRICE INPUT $ PRICE INPUT COST FUNCTIONS I I I I I I I MC I I I 1 I c TVC - Total Variable Cost AVC - Average Variable Cost MC - Marginal Cost 2 Dutput (Prepared by Carl Zulauf, Assistant Professor, The Ohio State Univ(•rsity, 4/84.) TC - Total Cost Figure 2. Total and Per Unit Cost Curves $ (Cost of Input) TVC - Total Variable Cost TFC - Total Fixed Cost $ (Cost of Input) MC - Marginal Cost ATC - Average Total Cost AVC - Average Variable Cost AFC - Average Fixed Cost SUPPLY CURVE LINE SEGMENT BDC Output Output (Pr0pnred by Carl Zulauf, Assistant Professor, The Ohio State University, 4/84.) $/BU. 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1. 50 1.00 .50 Figure J: llistribulinn ol Cash <~nd Total Costs for 54 Corn En tt.' rp r h;es, Oh Lo, 1982. LOW COST PRODUCER HIGH COST PRODUCER Range of Costs: Cash - $. 77 to $3.95 per bushel Total- $ .1. 53 to $4. 79 per bushel Source: Farm Business Analysis Project, Department of Agricultural Economics and Rural Sociology, Ohio Cooperative Extension Service, The Ohio State University. 4 S/BU. 11.00 10.00 9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00 Figure 4: Distribution of Cash and Totnl Cost Curves for 28 Soybean Enterprises, Ohio, 1982. TOT/\L COST CASH COST LOW COST PRODUCER HIGH COST PRODUCER Range of Costs: Cash - $2.58 to $8.68 per bushel Total - $'l.86 to $10.89 pvr htthiH·I SOU(('(.': Farm Business Analysis Projl'CL, J)c>p<Jrtlllt'llt or /\gricultllr.tl I•:conomics <Inti Rurdl Sociology, Ohio CoopL•r.Jtivv Ext<'llhion SL'rvic<:, TltL' Ohio Slat(' University. 'L1b I e 1. Return Above Total Costs for Corn, Soybeans, and Wheat; Price of Farmland; Rental Value of Cropland; and Acres of Corn, Soybeans, and Wheat Harvested; Ohio, 1972-1982. " Rt•turn Cnrn-b Above Total Costsa -- -- -- - -- -Soybeans Whedt (cents/bu) Price of Farmland ($/acre) Rental Value of Cropland ($/acre) Acres of Corn, Soybeans & When t Harvested (Thous.) 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 -6 41 65 37 10 -14 -26 -24 20 -38 -48 60 163 206 82 155 86 51 9 23 -111 -45 -44 117 118 -2 -55 -103 -41 -9 -73 -159 -189 439 505 627 706 846 1099 1224 1483 1678 1727 1474 28.40 29.20 33.90 40.40 50.80 59.80 68.00 76.80 81.80 87.70 88.40 7,315 7,570 8,633 8,585 8,560 8,890 8,800 9,230 9,245 8,900 9,040 a Average for Ohio farmers participating in The Ohio State University Farm Records Program. b Corn for grain. Sources: The Ohio State University, Ohio Agricultural Research and Development Center (in cooperation with Ohio Crop Reporting Service, U.S. Department of Agriculture). Ohio Agricultural Statistics 1970-1975. Research Bulle-tin 1106. Wooster, Ohio. November 1978. The Ohio State University, Ohio Agricultural Research and Development Center (in cooperation with Ohio Crop Reporting Service, U.S. Department of Agriculture). Ohio Agricultural Statistics 1976-1979. Research Bulle-tin 1139. Wooster, Ohio. October 1981. The Ohio State University, Ohio Cooperative Extension Service, Department of Agricultural Economics and Rural Sociology. Farm Business Analysis ~ep~rt, G~nera1 Crop Summary. 1972-1982. U.S. Department of Agriculture, Economic Research Service. Farm Real Estate Market Dev~lopments--Outlook and Situation. CD-88. August 1983. U.S. Department of Agriculture, Economics, Statistics, and Cooperatives Ser-vice. Farm Real Estate Market Developments. CD 85. August 1980. U.S. Department of Agriculture, Statistical Reporting Service, Ohio Crop Reporting Service. Ohio Agricultural Statistics. 1980-1982. Table 2. Labor and Management Costs of Growing Corn, Central Illinois, Selected Years 1926-1982. 7 Per Acre Costs Labor and Management b Total Costs as a Percent Labor Management Costs of Total Costs - $ - - - - % -1931-32 1941-42 1951-52 1959-60d 1971-72 1981-82 5.19 2.34 2.84 8.48 8.56 16.00 30.00 1. 38 .95 1.02 2.66 3.87 6.93 19.93 a Data are averages for the two years. 29.08 22.6 19.96 16.5 21.51 17.9 55.96 19.9 81.20 15.3 145.43 15.8 418.43 11.9 b Calculated as five percent of total cost per acre excluding the charge to management. cFirst two years data available. dData not available for 1961-62; therefore, data for 1959-60 used. Source: Various Illinois Detailed Cost Studies. Obtained by personal communication with Royce A. Hinton, University of Illinois. CAI'!TAI.!Z/\'I'ION OF LAND VAI.liES No l'rin' Su_pport Prograf!l J\s!->umptlons An average ownership life of 25 years, an opportunity cost of three percent (long-term real rate of interest), a corn price of $2.50 per bushel, a $2.00perbushel cost of production, a yield of 120 bushels per acre, no expected change in corn price, cost of pro-duction, yield; and no expected appreciation of land values. Value of Land ($2.50-$2.00)(120) = $60/year Therefore, the landowner has an annuity of $60/year for 25 years from owning the land. Present Value of Annuity = $60 (17 .41>'<) = $1044 per acre 'l'herefnn', <1 r<ll ional f<lrmcr would hid $1(JII4/acrc for the land. effect _of Price Suppor_t Program Assumptions Same as above except that a price support level of $2.75 per bushel is established by the government. Value of Land ($2.75-$2.00)(120) = $90/year Present Value of Annuity = $90 (17.41*) = $1567 per acre The government price support program has increased the present value of land by $523/acre. A rat iona1 land owner would increase his land bid by .1 correspond tng amount. *Number taken from: Chemical Rubber Company. Standard Mathematical Tables. 17th ed. 1969. COST CONCEPTS VARIABLE COSTS - Costs associated with variable factors of production. FlXED COSTS - Costs associated with fixed factors of production. SliNK COSTS - Costs incurred during the production process as of the present point in the production process. CASH COSTS - Cost which must be met by current funds. Funds could be SALVAGE VALUE internal funds or borrowed funds. If the latter, then the interest on borrowed funds becomes a cash cost. Cash costs equal or exceed variable costs. Value of a fixed factor of production in its best alterna-tive use. The more specialized the input the lower its salvage value as a percent of its purchase value. Pl1RCHASED COSTS - Costs associated with inputs purchased in the market place. RI:SIDUAL COSTS - Costs whose value are assigned by the manager at the end of the production process. These costs are assigned to pur-chased fixed factors of production which are completely paid off and to fixed factors not purchased in the market. P < AVC P <- ACC DRF < SV SHUTDOWN POINTS Traditional shutdown point in economic theory for a purely competitive firm. Price does not cover variable costs so entire production process is shutdown. Usually associated with bankruptcy. Average cash cost per unit of output cannot be covered. Individual moves out, resource bought by some other producer, no decline in pro-duction. Discounted long-term stream of revenue to a fixed factor of production is less than salvage value. Factor is moved out of production. If factor is land, then total crop pro-duction will decline. If factor is not land, production is not reduced, simply moves to other producers. OTHER CONSIDERATIONS Inputs are purchased until their cost equals their marginal value product or until their contribution is equal to that of all other factors of production (principle of equimarginal returns). A firm can adjust to decline in revenues through reducing its payments to n•sidual costs, selling off part of fixed inputs, or by reducing use of variable inputs. 9 

A Guide to Understanding Farm Production Costs

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A Guide to Understanding Farm Production Costs

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