Agricultural Economics Lecture 2 http www farmingfirst orggreeneconomy

Agricultural Economics Lecture 2

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Introduction to Agricultural Economics • Agricultural economics surveys agriculture and the food industry in its many facets and forms. • The agricultural economist is concerned with the entire food and fiber system. – From inputs used, all the way through the production, processing, distribution, and consumption chain. • Study of agricultural economics covers much more than just the activities of farmers or ranchers. – Some economists deal with issues of resource conservation, pollution control, and water management. – Others study the agribusiness sector as purchasers, processors, and distributors of food and fiber products. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics AGRICULTURAL ECONOMICS • The objective of any scientific inquiry is to… – Observe & describe a particular range of phenomena. – Organize those observations into recognizable patterns. – Formulate “laws” where sufficient regularity warrants. • The laws give scientist a basis on which to make predictions. • Economics is a social science, and social scientists must deal with the laws of human nature. – As humans are not consistent in their behavior, the laws of the social scientist are less reliable & more open to exception than those of physical or biological scientists. – Nevertheless, economic behavior of most persons is generally consistent, and thus, predictable to a degree. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics AGRICULTURAL ECONOMICS • Economics is that particular social science that deals with the allocation of scarce resources among an unlimited number of competing alternative uses. • The word “resources” describes anything tangible: – Wheat, barbed wire, hamburgers, water, labor, clean air. • Every resource is relatively scarce, meaning the availability of every resource is insufficient to satisfy all of its potential users. • Scarcity creates the need for a system to allocate the available resource among some of those potential users. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics AGRICULTURAL ECONOMICS • Agricultural economics is the social science that deals with the allocation of scarce resources among competing alternative uses found in the production, processing, distribution, and consumption of food and fiber. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics BASIS FOR ECONOMICS • The study of economics rests on three foundations: – Self-interest, scarcity, and choice. • Without scarcity, there would be no need for an allocation system. • Choice is important, because without choices there is no decision to be made. – Since economics is about decision making & allocation, without choices there would be no need for economics. • Self-interest is what drives the consumer to seek more “stuff ” at a lower price. – It also drives the producer to produce as efficiently as possible—all economic activity is driven by self-interest. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics BASIC ECONOMIC DECISIONS - Five Issues • Every economic system must resolve five basic issues: – – – What to produce. How to produce it. How much to produce. When to produce. For whom to produce. • These basic questions must be answered in each society—they simply cannot be avoided. – Institutional & political systems of each society determine the manner in which these decisions will be made. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics ECONOMIC SYSTEMS • At one extreme of possible allocation mechanisms lies the free market or price system. – Each individual producer and consumer, restricted only by financial resources, is free to choose what, how much, and when to produce or consume. • Financial resources of each consumer resolves the “for whom” question. • At the other extreme is the command system. – All decisions are made by a central planning agency or other administrative individual such as an absolute dictator or tribal chief. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics ECONOMIC SYSTEMS - Price System • An advantage of the price system is consumer sovereignty and freedom in economic decisions. – The price system is a very efficient mechanism for the “what, ” “how much, ”& “when” decisions. • Its does have shortcomings, which even its most ardent supporters recognize. – In a price system, the old adage, that the “rich get richer and the poor get poorer, ” has some validity. – There a number of resources that a price system cannot efficiently allocate. • Frequently called public or nonmarket goods, these include education, national defense, and fire protection. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics ECONOMIC SYSTEMS - Command System • Advantages of a command system are that it is very effective in allocating public goods. – And can be quite egalitarian in “for whom” decisions. • Disadvantages of such an allocation system are loss of individual freedom in economic decisions. – And inherent inefficiencies of central planning agencies. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics BASIC SKILLS OF AGRICULTURAL ECONOMISTS • The study of agricultural economics provides the student with an opportunity to explore phenomena common to everyday life from the perspective of an analytical scientist. • The role of the economist is to devise rules for making decisions in an ever-changing, uncertain economic environment. – These rules can be used to make production, consumption, marketing, and financial decisions. • Studying logic of these managerial rules, a student can learn to adjust decisions to changing environments in which economic activity occurs. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics Economic Models • It is impossible for economists to explain, much less predict all behavior—different people act differently. – As a general rule, people act in similar, predictable ways. • An expected pattern of economic behavior is called an economic model. – The basic building block in the logic of the economist. • A model usually will include… – Some assumptions about human behavior. – Other assumptions about the institutional environment in which a particular form of human behavior takes place. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics Economic Models • The economist uses the model to attempt to describe appropriate economic behavior. – Leading to the eventual achievement of some goal. • A frequently used economic model is the “perfectly competitive firm, ” with a number of assumptions about the firm & the its operating environment. – The assumption is made that the firm is so small relative to the market that its actions will not affect the market. – Also that the firm manager attempts to maximize profits given a particular resource endowment. • Are the assumptions valid? • If not the results may not be appropriate. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics Economic Models • At best, economic models approximate reality in a manner that enhances our ability to conceptualize and simplify the real world we are examining. – Models provide the economist with an internally consistent mechanism for conceptualizing problems. – They force the economist to reason in a systematic, deductive manner. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics Ceteris Paribus • Ceteris paribus is a Latin phrase that roughly translates to “everything else being equal. ” – Generally any economic principle is valid only when all other external factors remain the same. • Use of ceteris paribus gives economics much of the logical rigor required in a scientific inquiry. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics Opportunity Cost • A powerful economics concept is opportunity cost. • All economic resources have value. – Value is sometimes determined in a marketplace where the user of a resource pays the prevailing price for the use of the resource. – Other times, resources have economic value, but those resources are not purchased in the open market. • In the latter case, economists use the principle of opportunity cost to determine the economic value of a resource. – Though there is no manifest market price of that resource. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics Opportunity Cost • Opportunity costs cannot be measured directly. – They can only be estimated indirectly. • The study of economics is all about economic values —costs and returns. – When available, we use market prices to determine economic value. – When market prices are not available, we use the concept of opportunity cost to estimate those values. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics Diminishing Returns • In the economics of production and consumption, the concept of diminishing returns is central to the process of economizing. • The basic idea of diminishing returns is that as you increase the amount of something, ceteris paribus will eventually increase at a decreasing rate. – Diminishing returns. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics Diminishing Returns • The idea of diminishing returns is expressed in the “law of diminishing marginal utility. ” – Marginal utility refers to the additional utility or satisfaction associated with one additional unit of a good being consumed—ceteris paribus. • What this law says is that the amount of total utility gained from consuming a good eventually increases at a decreasing rate. – Assuming consumption of everything else stays constant. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics Marginality • One of the greatest contributions of economics is the concept of marginality. – In economics, the term marginal refers to an additional or an incremental unit of something. • Most economic analyses deal not with the marginal value of production or consumption. – It is on the margin where economic decisions are made. • As the consumer consumes additional units of a good, ceteris paribus, additional satisfaction or utility obtained by each unit decreases. – At any given consumption level, economists focus on the economics of the marginal or additional unit. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics Marginality • The relevant economic question of the consumer should be… – Is the marginal utility associated with one additional unit greater than the marginal cost of acquiring that unit? • Regardless of current level of satisfaction or utility, if the marginal utility is greater than the marginal cost, the consumer can increase total utility by consuming the marginal unit. – The same basic principle applies to production as well • As additional units of fertilizer are applied to a given amount of land, ceteris paribus. – Incremental or marginal returns to that fertilizer decline. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics Marginality • Using marginal analyses, we are able to determine economic optimizing behavior. – Ignoring total costs or returns & concentrating on marginal costs and returns, we are able to focus on the economizing process. • From the economist’s perspective, everything happens on the margin. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics FACTS, BELIEFS, AND VALUES • Since economics inevitably must deal with the value system of individuals and society, it is important to distinguish among facts, beliefs, and values. Facts are what we know to be the case. Beliefs are what we think to be the case. Values are what we think should be the case. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458

Introduction to Agricultural Economics FACTS, BELIEFS, AND VALUES • As a social scientist, the agricultural economist studies man’s behavior as producer and consumer. – With words to describe the behavior/environment taken from everyday language. tab Agricultural Economics, 3 th edition By H. Evan Drummond and John W. Goodwin © 2011, 2004 Pearson Higher Education, Inc. Pearson Prentice Hall - Upper Saddle River, NJ 07458