Farm Management Sample Lesson

The manager of a farm must be a skillful decision maker. Some decisions are easy and the best choice is obvious. Others are more difficult and need to be given careful consideration. Decision-making can be broken down into a series of steps that include recognizing the problem, gathering information and comparing alternative solutions. See AgEdNet.com lesson FM101 The Meaning Of Management in Farming.

TYPES OF DECISIONS

Every decision has at least two alternatives. It could simply be to do something or not to do it. Do you hire an additional worker or not? Do you buy a new tractor now or repair the one you have? Do you rent the additional 80 acres that has become available or not?

Some decisions may require choosing among several alternatives. If you rent that additional 80 acres, will you plant corn, wheat, soybeans or some other crop on that land? Some decisions require choosing the amount of an input to use. If you rent that 80 acres and plant corn, how much nitrogen fertilizer will you apply? The choices among alternative amounts of nitrogen to use start at zero increasing to as much as 200 or more pounds per acre.

Decisions are also needed for different periods of time. Management economists often divide decisions into three time horizons: 1) the short run, 2) the long run and 3) the very long run.

1. SHORT-RUN DECISIONS start with those daily decisions such as "what to do next," but extend well beyond daily operational decisions. The economic definition of "short-run decisions" includes any time period during which "the quantity of some inputs cannot be changed." These are called fixed inputs, such as the land available this year and the equipment inventory. Also, once an input has been applied, it is essentially fixed. The amount of fertilizer already applied is now a fixed input. It has become a part of the land.

2. LONG-RUN DECISIONS apply to a time period during which the manager or decision maker can make changes in all of the inputs being used. These are decisions such as buying or renting more land, adding new buildings, or purchasing additional equipment.

3. THE VERY LONG-RUN decisions apply to time periods during which new technology and/or new market opportunities become available to managers. For example, larger tractors, labor saving equipment and chemical weed control methods allowed farmers to operate more land with the same or less labor. Meanwhile, a growing new market for organic foods has encouraged some managers to change what they produce and how they produce it.

THREE USEFUL RULES

There are several economic principles that can help you in making management decisions for the short run or the long run. The three that are used most often are:

1. The law of diminishing returns;
2. The concept of marginal costs and marginal returns; and
3. The strategy of spreading overhead or fixed costs.

Each of these three applies to different types of situations. Following are some examples to help you learn how they can apply to decisions you may one day need to make. As you learned in earlier lessons, if you are going to manage a farm or any other type of business, you will need to make decisions on how to make the best use of land, capital, labor and management.

** THE LAW OF DIMINISHING RETURNS applies to the returns that can be earned for each variable input that is added. The rule says that the returns will increase for each unit added up to certain point where the returns will begin to decrease. This point of diminishing returns depends upon the effect the variable input has on production.

In crop production, for example, the three greatest variable inputs are fertilizers, seed and chemicals. Each one of these inputs can influence the yield per acre. However, using more seed, more herbicide or more fertilizer than necessary is wasteful. The manager needs to be able to determine the point at which returns for adding more of each input begin to diminish.

Decision making starts with gathering information. A manager needs to know how seed or fertilizer rates will influence yield per acre. Field test results, such as the example in the table below, can be very helpful.

EXAMPLE: Corn Yield Results at Increasing Seeding Rates
Seeds Planted per Acre	Plant Population	Bushels Yield per Acre
16,600	15,800	150
20,200	19,900	159
24,000	23,000	168
27,000	25,500	164
30,000	29,000	161

Notice that each increase in seeding rate increased yield up to 24,000 seeds per acre. At 27,000 seeds per acre, yield actually dropped, perhaps because the dense plant population did not give each plant adequate light, moisture and nutrients. Ears did not develop as well on plants that were too crowded. The point of diminishing returns was 168 bushels per acre. Increasing seeding rates beyond 24,000 seeds per acre would be wasteful.

** THE MARGINAL CONCEPT is another way to look at the diminishing return from adding inputs. The term "marginal" means the additional cost or additional return that can be produced by adding one more unit of an input. In this way a manager can more easily determine the points of diminishing returns for various inputs.

In the example below we will first look at the physical inputs and physical outputs. The inputs are amounts of nitrogen fertilizer added and the output is the amount of corn yield produced per acre. At 10 pounds of nitrogen per acre, the crop produced only 85 bushels per acre. The first 50 pounds of nitrogen added produced 35 bushels per acre, the next 50 pounds only 15 additional bushels, and the third 50 pounds only nine bushels. The final 50 pounds, with total nitrogen applied at a rate of 210 pounds per acre, produced only an additional 3 bushels of corn.

EXAMPLE: Marginal Corn Yield with Increasing Nitrogen Applications
Pounds of Nitrogen	Bushels Corn Yield per Acre	Marginal Corn Yield
10	85	0
60	120	35
110	135	15
160	144	9
210	147	3

With this kind information, a manager can easily use the cost of nitrogen and the expected price of corn to determine what rate of nitrogen will produce the maximum return. For example, the table below shows that with nitrogen at 25 cents per pound and corn at $2.20 per bushel the marginal corn value and marginal return over the cost of nitrogen are as follows:

EXAMPLE: Marginal Returns with Increasing Nitrogen Applications
Pounds of Nitrogen	Bushels Corn Yield per Acre	Marginal Corn Yield	Marginal Corn Value	Marginal Return*
10	85	0	$0.00	$0.00
60	120	35	77.00	64.50
110	135	15	33.00	20.50
160	144	9	19.80	7.30
210	147	3	6.60	(5.90)
* Value of corn produced above the cost of nitrogen added, assuming 25 cents per pound for nitrogen and $2.20 per bushel for corn.

The inputs to use and the amount of each should depend on the added yield potential and the expected market price, so that the highest net profit will result. In the example above, each 50 pounds of nitrogen adds $12.50 to input costs. The third 50 pounds added produced nine bushels of corn worth $19.80 or a $7.30 gain. Meanwhile, the fourth 50 pounds added only three bushels of corn worth $6.60 or a loss of $5.90 ($6.60 corn value - 12.50 cost of nitrogen = -$5.90)

** SPREADING OVERHEAD is another strategy that a manager can use to improve the net return of a farm or business. Consider the corn farmer example you learned about in AgEdNet.com lesson FM102 Understanding Farm Costs and Profits. The following table shows the net family income from the 100 acres of corn.

Corn Example Costs, Returns and Family Income from 100 acres
Direct Operating Expense		Allocated Overhead
Seed	$3,500	Equipment Depreciation	$2,500
Fertilizer	4,200	Mortgage Interest	6,000
Chemicals	2,500	Taxes and Insurance	600
Custom Combining	1,200	General Farm Overhead	1,200
Fuel and Power	2,300	Total Overhead	$10,300
Equipment Repair	1,200
Interest on Crop Loans	100
Total Operating Expense	$15,000	Total Cost	$25,300
Value of Corn Sold	$33,600	Value of Corn Sold	$33,600
Return over Direct Expense	$18,600	Net Family Income from Corn	$8,300
		Net Family Income per Acre of Corn	$83

Now let's assume the farm includes 20 acres of idle land that had been used as a pasture but was producing little or no additional income for the farm. How much could family income be improved if the 20 acres were also planted to corn? The table below shows the results.

Operating costs are increased to account for the additional 20 acres. Meanwhile, the allocated overhead costs can be spread over the additional 20 acres, assuming that no additional equipment needs to be purchased. Mortgage interest has not increased, nor have the taxes, insurance and general farm overhead. Thus, net family earnings from corn increase from $83 to over $100 per acre.

Corn Example Costs, Returns and Family Income from 120 acres
Direct Operating Expense		Allocated Overhead
Seed	$4,200	Equipment Depreciation	$2,500
Fertilizer	5,040	Mortgage Interest	6,000
Chemicals	3,000	Taxes and Insurance	600
Custom Combining	1,440	General Farm Overhead	1,200
Fuel and Power	2,760	Total Overhead	$10,300
Equipment Repair	1,440
Interest on Crop Loans	120
Total Operating Expense	$18,000	Total Cost	$28,300
Value of Corn Sold	$,40,320	Value of Corn Sold	$40,320
Return over Direct Expense	$22,320	Net Family Income from Corn	$12,020
		Net Family Income per Acre of Corn	$100

BOTTOM LINE: Three useful management principles are the law of diminishing returns, the concept of marginal costs and returns, and the strategy of spreading overhead. All three can be useful in making decisions on the use of land, labor, capital and management in a farm business.

EXERCISES:

1. The net return from using a farm input such as fertilizer will depend on the cost of the input and the price that can be received for the output. The marginal return table in this lesson is based on nitrogen at 25 cents per pound and corn at $2.20 per bushel.

A. How would the table change if nitrogen was 35 cents per pound and corn was $2 per bushel? Did that change when the point of maximum return for nitrogen was reached?

B. What is the marginal cost of nitrogen in our example when nitrogen is priced at 25 cents a pound vs. 35 cents a pound?

2. The table used in the lesson reference to demonstrate the marginal concept showed decreasing marginal returns for increasing amounts of nitrogen. The marginal concept can also be used to show increasing marginal costs.

A. Show how you could construct a table showing the increasing marginal cost per bushel of corn based upon the same crop yield data. Assume 35 cents per pound for nitrogen.

B. Explain how you could use your marginal cost table to make a decision on how much nitrogen to use on corn.

3. Review the table below showing costs for producing 120 bushels of corn per acre.

A. Revise the table showing how costs would change if you could add 100 pounds of nitrogen at 25 cents a pound and get approximately the same yield response shown the lesson example table "Corn Yield Results at Increasing Seeding Rates."

B. What management principle caused the cost per bushel to change? Explain how the principles applied to this example.

Cost Per Bushel of Producing 120 Bushels of Corn per Acre
Direct Operating Expense		Allocated Overhead
Seed	$35	Equipment Depreciation	$55
Fertilizer	22	Mortgage Interest	85
Chemicals	25	Taxes and Insurance	6
Custom Combining	12	General Farm Overhead	12
Fuel and Power	23	Total Overhead	$158
Equipment Repair	12
Interest on Crop Loans	1	Total Cost Per Acre	$288
Total Operating Expense	$130	Total Cost per Bushel	$2.40

TEST:

1. Complete the following statements:
A. A decision can often be described as choosing do something or __________ .
B. A decision may require choosing among several __________ .
C. A decision may require choosing the __________ of an input to use.

2. Economists divide decisions into three time horizons. Write a brief definition for each of the three time periods listed below:
A. The short run is a time when:
B. The long run is a time when:
C. The very long run is a time when:

3. Name the three management principles or rules discussed in this lesson.
A.
B.
C.

4. The term "__________" means the additional cost or additional return that can be produced by adding one more unit of an input.

5. In the lesson examples, 160 pounds of nitrogen is the maximum amount that can be used before the returns turn negative. TRUE or FALSE? Explain.

6. Direct or variable costs can be controlled, but there is little or nothing a manager can do about fixed costs such as depreciation on a tractor or interest on mortgage payments because these costs are fixed and will continue year after year. TRUE or FALSE? Explain.

-----------------------------------------------------------------------------
Copyright © 2004 Stewart-Peterson, Inc. All Rights Reserved. RF/nc 405101
STEWART-PETERSON and AGEDNET.COM are registered trademarks of Stewart-Peterson, Inc.

END STUDENT SECTION

TEACHER'S GUIDE

PREPARATION: Review lesson content and be ready to help students with suggested exercises. You also may want to discuss how these principles can apply to other crop and livestock enterprises that are typical in your area. See the suggested extension below.

IMPORTANT TERMS: alternatives, decisions, diminishing returns, long-run decisions, inputs, marginal costs, marginal returns, outputs, short-run decisions, spreading overhead, units, very long-run decisions, yields.

EXTENSION: Offer extra credit for students who do research to find supporting data and use it to demonstrate the use of marginal costs and/or marginal returns to make decisions about adding inputs to a farming enterprise that is typical of your area. Point out that the concept can be applied to a wide range of inputs in addition to seed or fertilizer, such as adding one more worker or adding one more cow to a dairy herd.

EXERCISE ANSWERS:

1. The answers are as follows:

A. The revised table at 35-cent nitrogen and $2 corn is shown below. The marginal corn value and marginal return numbers are smaller than at 25-cent nitrogen and $2.20 corn. The point at which the returns turn negative remains the same.

B. Marginal cost is the cost of adding one unit. In the lesson example, each unit added is 50 pounds of nitrogen. At 25 cents per pound of nitrogen, the marginal cost of adding 50 pounds is $12.50. At 35 cents per pound of nitrogen it is $17.50.

EXAMPLE: Marginal Returns with Increasing Nitrogen Applications*
Pounds of Nitrogen	Bushels Corn Yield per Acre	Marginal Corn Yield	Marginal Corn Value	Marginal Return
10	85	0	$0.00	$0.00
60	120	35	70.00	52.50
110	135	15	30.00	12.50
160	144	9	18.80	0.50
210	147	3	6.00	(11.50)
* Assuming 35 cents per pound for nitrogen and $2.00 per bushel for corn.

2. The answers are as follows:

A. An example marginal cost table is shown below. To construct the table, the student will need to divide the marginal cost of nitrogen by the marginal yield produced with each 50 pounds of nitrogen added. The marginal cost of nitrogen at 35 cents per pound is $17.50.

B. A farmer could use this information by comparing the marginal costs with the price of corn. It will be profitable to add nitrogen as long as the marginal cost is less than the price the farmer expects to get for corn. In this example, a farmer could make profitable use of up to 160 pounds of nitrogen as long as the price of corn is higher than $1.95 per bushel.

EXAMPLE: Marginal Cost of Nitrogen per Marginal Bushel Yield*
Pounds of Nitrogen	Bushels Corn Yield per Acre	Marginal Corn Yield	Marginal Cost per Bushel
10	85	0	$0.00
60	120	35	0.50
110	135	15	1.67
160	144	9	1.95
210	147	3	5.83
* Assuming 35 cents per pound for nitrogen

3. The answers are as follows:

A. The additional 100 pounds of nitrogen would cost $25 and increase the yield to 144 bushels per acre based on the lesson table data. This increases the cost per acre from $288 to $313, but reduces the cost per bushel from $2.40 to $2.17. See revised table below.

B. The principle of spreading overhead has caused the cost per bushel to drop from $2.40 to $2.17. The only change in cost is fertilizer. All overhead and other costs remain the same. At 120 bushels per acre, overhead per bushel is $1.32 (158/12 = 1.3166). At 140 bushels per acre overhead per bushel drops to $1.10 (158/144 = 1.097222) In addition, the direct costs that do not change are also reduced per bushel produced.

Cost per Bushel of Producing 144 Bushels of Corn per Acre
Direct Operating Expense		Allocated Overhead
Seed	$35	Equipment Depreciation	$55
Fertilizer	47	Mortgage Interest	85
Chemicals	25	Taxes and Insurance	6
Custom Combining	12	General Farm Overhead	12
Fuel and Power	23	Total Overhead	$158
Equipment Repair	12
Interest on Crop Loans	1	Total Cost per Acre	$313
Total Operating Expense	$155	Total Cost per Bushel	$2.17

TEST KEY:

1. Complete the following statement:
A. A decision can often be described as choosing do something or not do it.
B. A decision may require choosing among several alternatives.
C. A decision may require choosing the amounts of an input to use.

2. Economists divide decisions into three time horizons. Write a brief definition for each of the three time periods listed below:
A. The short run is a time when the quantity of some inputs cannot be changed.
B. The long run is a time when changes can be made in all inputs being used.
C. The very long run is a time when new technologies or new market opportunities become available for the managers.

3. Name the three management principles or rules discussed in this lesson.
A. The law of diminishing returns
B. The concept of marginal costs and marginal returns
C. The strategy of spreading costs

4. The term "marginal" means the additional cost or additional return that can be produced by adding one more unit of an input.

5. In the lesson examples, 160 pounds of nitrogen is the maximum amount that can be used before the returns turn negative. TRUE or FALSE? Explain.

FALSE. The example used was for adding units of 50 pounds of nitrogen. The last 50 pounds, up to 210 pounds produced a negative return. However, the data does not show if adding just 10 pounds, increasing the amount to 170 pounds, would be profitable. It is possible that adding 25 pounds up to 185 pounds could also be profitable. More data on yield response would be needed to determine that 160 pounds is the maximum profitable amount.

6. Direct or variable costs can be controlled, but there is little or nothing a manager can do about fixed costs such as depreciation on a tractor or interest on mortgage payments because these costs are fixed and will continue year after year. TRUE or FALSE? Explain.

FALSE. Fixed or overhead costs can be spread over more units of production. Using a tractor on more acres will spread tractor costs over more units of production. When doing this, the fixed tractor costs per unit produced will be reduced. Using practices that increase yield per acre will help to spread fixed land costs. Producing and selling more bushels reduces the fixed cost per bushel.
-----------------------------------------------------------------------------
Copyright © 2004 Stewart-Peterson, Inc. All Rights Reserved. RF/nc 405101
STEWART-PETERSON and AGEDNET.COM are registered trademarks of Stewart-Peterson, Inc.

END

To subscribe to AgEdNet.com or for a "free trial",
call us toll-free at 800-236-7862.

Back to top