The following article will guide you about how to make rational farm management decision by following some basic principles.
1. The Law of Returns or the Law of Variable Proportions:
This law deals with the Factor -Product or Input-Output relationship where the Product is the function of the factor.
y = f(x)
The conditions for obtaining the output levels of the variable input and that of the output, giving positive maximum profits are in the following two alternative forms-
Where,
Here it is explained by the table and production function curve (PFC).
Production Function Curve:
These are the inference drawn from the Production Function Curve:
(1) Total Physical Product of x (TPPx) rises at increasing rate of return; MPPx rising and Production function curve is concave upward.
(2) Beyond Inflexion Point ‘A’; TPPx rises but at diminishing rate and MPPx starts to decline.
(3) TPPx is highest at ‘B’ or remains constant; and MPPx =0.
(4) TPPx decreases then MPPx becomes negative.
(5) At Point ‘D’; MPPx = APPx and APPx is maximum.
(6) When MPPx > APPx (more than APPx); then APPx is increasing.
(7) When MPPx < APPx (less than APPx); then APPx is decreasing but never becomes negative.
The percentage change in output due to percentage change in input is called Elasticity of Production (Ep). It is the ratio of the percentage change in output to the percentage change in Input.
Inference from the formula:
(1) When MP = AP, then Ep =1.
(2) When MP > AP, then Ep > 1.
(3) When MP < AP, then Ep < 1.
(4) When MP = 0, then Ep = 0.
Profitability is increasing upto the increase in APPx = MPPx and there is no harm to the farmer. It is the minimum level of input- use (i.e. fertilizer use in this case). At this stage the farmer is in the First stage. Since in the first stage, profitability is undoubtedly increasing, therefore the first stage is called irrational zone.
Most of the Indian farmers are under stage I. But the farmers of Punjab, Haryana and Western U.P. are under stage II i.e. Rational zone where the farmer has to conscious to get highest profitability using the Cost Principle. When MPPx becomes zero and negative afterwards, the production is not profitable and the stage is third stage i.e. irrational zone.
Under the rational zone i.e. 2nd stage, the farmer has to calculate proper and optimum level to get maximum profitability.
2. Cost Principle:
To measure the optimisation condition, there are two methods:
(1) First Method:
At the point where marginal revenue (MR) is equal to marginal cost (MC); that point is the optimum point where the farmer gets maximum net profit.
The proportional marginal change in y to x, is equal to their opposite price ratio. It might be depicted by the cost principle curve.
In the above graph (cost principle curve) marginal return (MR) curve becomes equal twice to marginal cost (MC) i.e. at x1 and x2.
First time MR =MC is in the First stage (i.e. irrational zone) of the Production function curve (PFC) and Second time MR = MC is in the second stage (i.e. rational zone). In the second stage of PFC, MR curve starts to decline and cuts the price line of x at the point x2 where again MR =MC which denotes the optimum marginal rate of input. The shaded area of the MR Curve denotes net profit.
To get maximum profit in agri-business, three points should be essentially considered in the II stage (rational zone) of the PFC:
(i) MR = MC
(ii) MC Curve must be rising (see Different Cost Curve)
(iii) Total Revenue > Total Cost means total revenue must be greater than the total cost.
It becomes clearer from the cost principle table.
3. Law of Equi – Marginal Return (Principle of Opportunity Cost or Alternative Cost Principle):
According to this law, each unit of the limited or unlimited resources is to be invested in different enterprises in such a way that a farmer gets maximum marginal return. How a farmer can distribute each unit of input among two or more than two different enterprises, is studied and calculated as follows-
Suppose a farmer has 100 kg fertiliser. How can he distribute it on different crops say wheat, gram and barley so that he gets maximum profit?
It is clear from the above table that after the investment of initial 10 kg fertilizer, MR from wheat is Rs. 100/-, from gram is Rs. 120/- and from barley is Rs. 80/- In such case first dose of fertilizer (I) should be applied in the field of gram. Similarly IInd dose in gram, IIIrd dose in wheat, IVth dose in wheat and Vth dose in barley and so on according to the table. After 10th dose, the fertilizer is exhausted. If the cost of fertilizer is Rs. 5/- per kg, means 10kg fertilizer (one dose) costs Rs. 50/-
If the resource (here amount of fertilizer is 100 kg costing Rs. 500/-) is limited, a farmer cannot invest after the exhaustion of his input (say 10th dose i.e. 100kg fertilizer). But in case of unlimited resource (i.e. Plenty of fertilizer) the farmer invests it until MR = MC. Here MC= Rs. 5 X 10kg = Rs. 50/-; it means the farmer invests the input doses upto XVth dose in wheat where he gets MC = MR = Rs. 50/-. And it is the situation where we see Equi – Marginal Return in case of unlimited resources i.e. Rs. 50/- from wheat, Rs. 50/- from gram and Rs. 50/- from barley equal to marginal cost.
In the case of limited resource i.e. 100 kg fertilizer, the maximum return would be:
From Wheat – 100 + 90 + 80 + 70 = Rs. 340/-
From Gram – 120 + 110 + 80 + 70 = Rs. 380/-
From Barley – 80 + 70= Rs. 150/-
Total Return = 340 + 380 + 150 = Rs. 870/-
In the case of unlimited resources i.e. plenty of fertilizer, the maximum return would be:
From Wheat – 100 + 90 + 80 +70 + 60 + 50 = Rs. 450/-
From Gram – 120 + 110 + 80 + 70 + 50 = Rs. 430/-
From Barley – 80 + 70 + 60 + 50 = Rs. 260/-
Total Return = 450 + 430 + 260 = Rs. 1140/-
A farmer wishes to invest his Rs. 1000/- on the crop, poultry and dairy in the installment of Rs. 200/- and the total returns from the different enterprises are given in the table. Suggest the farmer how he can distribute his money among different enterprises so that he gets maximum return?
Solution:
Other factors viz. Diversification, Inclusion of legumes in the cropping system, local conditions etc. are taken into consideration in the investment on different enterprises in case of equal marginal returns . e.g. – IInd and IIIrd allocations and similarly IVth and Vth allocations in the above table.
4. Substitution between Inputs or Factor-Factor Relationship or Rate of Technical Substitution or Principle of Least Cost Combination:
This law is represented in algebraic form as-
Y = f(x1, x2)
Where y = output and x1 x2 are different inputs.
This principle explains – How the different units of the two or more than two variable factors of production of any commodity can be used so that a farmer gets same quantity of product at the comparatively lowest cost.
Isoquant curve is the curve/path showing various combinations of factors for producing the same quantity of output. It becomes clear from the following table and graph.
To produce 40 q wheat, either 100kg fertilizer and no irrigation or no fertilizer and 5 no. of irrigation or any other combination in between these two extremes is required. With the application of 1 irrigation, 10kg fertilizer application is reduced to produce the same output. Now we have to see whether application of 10kg fertilizer is cheaper or 1 irrigation is cheaper and this is explained by principle of least cost combination.
Isoquant curve may be upto infinity in number. Different isoquant curves show the different levels of production which are obtained from different combinations of two resources. Four isoquant curves are shown in figure.
The shape of isoquant curve depends upon the extent of substitutability (i.e. rate of substitution) of the two inputs:
(i) When two inputs are perfect substitutes, the shape of the isoquant is straight line.
(ii) If two inputs are good substitutes, the shape of the isoquant is slightly curved & convex to the origin.
(iii) If two inputs are poor substitutes; isoquant curve is having steep curvature.
(iv) If two inputs are to be used in fixed proportion i.e. absolutely non substitutable; isoquants are right angled.
Types of Factor – Substitution:
(a) Increasing Rate of Factor Substitution (IRFS):
If one factor of production factors’ combination is increased; the Marginal Rate of Substitution (MRS) of other factor is also increased e.g. the increase in number of irrigation (x1) increases the no. of intercultures (x2).
(b) Decreasing Rate of Factor Substitution (DRFS):
In agriculture, these is generally decreasing marginal rate of factor substitution because no two factors of production are perfectly substitutable. For example as the no. of irrigation increases, the requirement of fertilizer is reduced for producing the same output.
(c) Constant Rate of Factor Substitution (CRFS):
There is constant marginal rate of substitution e.g. perfect substitution.
Principal of Least Cost Combination:
Marginal Rate of Substitution:
The per unit increase in one factor decreases the unit change in the second factor; is known as the Marginal Rate of Technical (or Factor) Substitution (MRFS).
Price Ratio (PR):
To calculate such combination of factors which gives maximum profits i.e. optimum combination of resources; MRS is compared with PR viz. MRS<PR; MRS> PR, or MRS = PR
In such condition, the use of x2 factor in place of x1 factor should be increased until we get MRS = PR
It is the optimum combination to get maximum profit and such equilibrium point is called as Least Cost Combination.
To calculate least cost combination in factor – substitution, there are two methods.
(a) Simple Arithmetic Method:
Let x1 = Fertilizer in kg;
x2 = No. of irrigation
Px1 = Rs. 2/- per kg fertilizer
Px2 = Rs. 50/- per irrigation
y = 40 q/ha
In the above table, first condition is the cheapest costing Rs. 200/- only. Therefore the first condition is optimum combination of resources to produce same yield.
(b) Graphic Method:
Px2/Px1 is drawn on the graph where it is called Price Line or Iso –cost line or Iso- expenditure line.
Iso – cost line is the tangent to iso – quant curve where,
How to Draw Price Line?
Suppose a farmer wishes to invest Rs.100/- in the agriculture.
Px1= Rs.2/-per kg
Px2 = Rs.50/- per irrigation
If the farmer invests the whole money (i.e. Rs. 100/-) on x1 (i.e. fertilizer), he will use maximum 50 kg of x1 therefore to draw price line, we take maximum point 50 on oy – axis. Similarly if the farmer invests the whole money on x2 (irrigation), he will use maximum 2 no. of x2 (irrigation) in such condition, we take maximum point 2on ox-axis.
Now both the points (point 50 on oy – axis and point 2 on ox -axis) are connected with a straight line which will be the price line for input’s costs. Such price line is known as Iso -cost line or Iso- expenditure line. Each and every point of Iso- cost line gives the same expenditure.
To determine the least cost point by graphic method, different other price lines are to be drawn parallel to the first price line Px2/Px1 The point where the price line becomes tangent firstly to the Isoquant curve, will be the least cost point (LCP).
Left side of the price line shows lower cost and right side of the price line shows higher cost. The Least Cost point depends upon the slope of the price line. If the farmer has sufficient resources, he can shift to right side and follow other price lines. And thus he gets different least cost points viz. C1, C2, & C3 on different Isoquant Curve (IC). The change in price changes the all least cost points but at a certain time there is only one Expansion Path.
The line passing through the least cost points viz. C1, C2, C3 is called Expansion Path or combination of Iso -cost lines. The size of the expansion path depends on the production function. The poor farmer uses C2 point (first least cost point), middle farmer uses C2 point and the big farmer uses C3 point or any other least cost point (LCP) of right side.
Isocline and Ridge Line:
Isocline is the line passing through the equal slopes of the different isoquant curves. Expansion path is a particular isocline passing through the different least cost points. For expansion path, price line is a necessary.
Ridge line is the line passing through the maximum limits of the different isoquant curves i.e. parallel to the respective axis and thus isocline varies in between these two ridge lines.
5. Substitution between Products/Outputs or Product -Product Relationship or Output -Output Relationship:
The substitution between products or outputs takes place in two ways:
(i) According to the principle of Equi-marginal return where each enterprise is independent i.e. the two products are not inter-related.
Input________________ Products
x______________ y1, y2, y3 (Different Enterprises)
(ii) According to the principle of product -product relationship where the different products are interdependent or inter -related.
Input_________________ Products
x__________________ y1 , y2 (inter – dependent products)
(1) Joint Products:
Joint products are results from the same production function. Generally all agricultural products are joint products. In agriculture there is one Bye-product with each main product e.g. straw with wheat grain, Cow -dung with milk etc. For a short period, there is only one product but in a long period, there is substitution between products. In the joint products the farmer emphasises on the main product.
(2) Complimentary Relationship:
The change in the level of one product changes the level of other product in the same direction. It means the increase or decrease in the production level of one product increases or decreases the other’s respectively. Such products are called complimentary products e.g. mixed cropping of Wheat + Gram where the yield of wheat increases due to nitrogen -fixation by gram, the increase in the number of catties increases the quantity of dung manure.
But two enterprises are not always complimentary over-all possible combinations of the two. And such relation always gives the way to competition e.g. Excess forage area reduces the grain production. The complimentary relationship after a certain point becomes competitive i.e. after the points B and C in the given graph.
(3) Supplementary Relationship:
The increase or decrease in the production level of one product does not affect the production level of the other product. Such type of relationship between product and product is called supplementary relationship. Here one enterprise is subsidiary enterprise and its contribution is 10% to the total Farm income. Subsidiary enterprises utilise the bye-products and the surplus labour e.g. Rearing of livestock and cultivation of crop; cultivation of bottle gourd with sugarcane etc.
(4) Competitive Relationship:
When the increase in the production level of one product necessarily decreases the production level of the other product, such relationship is called competitive one. And when two products are competitive, they may substitute at constant rate, increasing rate or decreasing rate.
(a) Constant Rate of Product Substitution (CRPS):
For example, Gram and Wheat substitute for land at constant rate.
(b) Production Possibility Curve (PPC):
The path or locus passing through various combinations of the products y1 & y2 obtained with fixed level of resources or resource combinations is called Production Possibility Curve. PPC is also called Transformation or Iso- revenue curve/Iso –return curve/Iso -income curve/or opportunity curve. When PPC is a straight line then it is called production possibility line (PPL).
(c) Decreasing Rate of Product Substitution (DRPS):
Two Products within a limited range may substitute at decreasing rate e.g. the substitution between Dairy and crop in short duration.
(d) Increasing Rate of Product Substitution (IRPS):
The increase in the level of one product decreases the level of other product substantially e.g. the substitution between labour and capital; Rice & Maize. Such type of substitution is common in agriculture sector.
The above relationships are summarised below:
Iso – Revenue Line:
Iso- revenue line is also called iso-return line or iso-income line. This line is to be drawn on the basis of Py2/Py1. Py2/Py1 is a price line but here price indicates the price of the product/output. Therefore it is called iso-revenue line.
There are two methods to get optimum combination of the two products viz. arithmetic calculation method and graphic method.
(i) Simple Arithmetic Method:
Let,
Py1 = Rs. 7 / – per kg for y1; Py2 = Rs. 10 / – per kg for y2
From the above table, it is obvious that 5th combination is the optimum to get highest return/income.
(ii) Graphic Method:
The highest return from optimum product combination is calculated by production possibility curve (PPC) and Iso- revenue line (Py2/Py1)
In the graph, point ‘C’ is the maximum revenue point where Iso-revenue line is lastly tangent to PPC, Just opposite to find out least cost point.
Here Expansion path is the path or locus passing through the different maximum revenue points of the different production possibility curves.
When the price of the product y1 is increased, the farmer has to produce the product y1 more in place of y2.
There may be three forms or conditions on the basis of marginal rate of product substitution (MRPS):
In such condition, the farmer has to produce the product y1 more in place of y2.
In such condition, the farmer has to shift on to produce the product y2 more in place of y1 because after producing y2 more he will get more revenue.
In such condition, to produce both the products is equally profitable. It means the farmer may either produce y1 or y2 which gives equal return.
6. Principle of Comparative Advantage:
When the capital is marginal, percent profit (advantage) or profit per rupee becomes more important, although all the principles of farm management are based on the concept of marginal capital. According to this principle, the farmer has to produce such things in each region whose production gives more comparative advantage or lowest comparative loss in comparison to other regions.
According to Black, “Each area tends to produce those products for which its ratio of advantage is greatest compared with other area or its ratio of disadvantage is least.”
Decision under Risk and Uncertainty:
The variability in future output which is not measured is called uncertainty and it is not insurable. If it is measurable, it is called Risk and Risk is insured e.g. – Group Insurance, Life Insurance, Crop Insurance. For example, Crop failure is the risk for Insurance Company but it is uncertainty for the farmer.
The protective measure against risk is Insurance and the measure against uncertainty is Diversification or growing of crops with low variability in output. To insure the crop, Crop Insurance Scheme has been launched. The precursor of Crop Insurance Scheme was Benjamin Franklin.
Two types of Crop Insurance are:
(i) Compulsory and
(ii) Optional.
In 1973, to cover Cotton, Wheat, Groundnut and Potato; a kind of insurance under the auspices of General Insurance Corporation (GIC) was initiated first time in India.
National Agricultural Insurance Scheme (NAIS):
National Agricultural Insurance Scheme was announced in June, 1999 by Sri Atal Bihari Bajpayee, then prime minister of India. Some lacunae and limitations, present in the Comprehensive Crop Insurance Scheme (CCIS) initiated in 1985, have been removed in this scheme.
Under CCIS some crops viz. Wheat, Rice and Oilseeds were only covered and thus Commercial Crops like Sugarcane, Potato and Cotton were bereft from CCIS. Only rainfed crops were insured and only those farmers were benefitted who availed the loan.
The insurance value was maximum Rs. 10,000/- and was taken in the form of loan from the institutional sources. Whereas NAIS is incomparable and under which all the farmers including commercial and horticultural farmers would be benefited.
This scheme provided the protective net to the farmers in the case of Crop-failure due to natural hazards and insect pests and diseases. This scheme was initiated from the Rabi season of the year 1999-2000 and was planned for minimum five years.