agribusiness

1. CHAPTER 11CHAPTER 11
•Input Combinations
•Enterprise Combinations

2. Learning OutcomesLearning Outcomes
1.1. Understand the concept of substitution inUnderstand the concept of substitution in
economics and use it decision making.economics and use it decision making.
2.2. Know how to compute substitution ratio andKnow how to compute substitution ratio and
price ratio for two inputs.price ratio for two inputs.
3.3. Use the input substitution and price ratiosUse the input substitution and price ratios
to find the least-cost combination of twoto find the least-cost combination of two
inputs.inputs.
4.4. Understand the characteristics ofUnderstand the characteristics of
competitive, supplementary, andcompetitive, supplementary, and
complementary enterprises.complementary enterprises.
5.5. Use the output substitution and price ratiosUse the output substitution and price ratios
to find the profit-maximizing combination ofto find the profit-maximizing combination of
two enterprises.two enterprises.

3. Input CombinationsInput Combinations
Most products require two or more
inputs, and the manager may choose
the input combination or ratio to use.
The economic question is whether
one input can be substituted for
another to reduce the cost.

4. Types of Input SubstitutionTypes of Input Substitution
• Constant rate (perfectConstant rate (perfect
substitution)substitution)
• Decreasing rate (more and moreDecreasing rate (more and more
added to replace 1 input)added to replace 1 input)
• OR No substitutionOR No substitution

5. Three possible types ofThree possible types of
substitutionsubstitution

6. Input Substitution RatioInput Substitution Ratio
addedinputamt
replacedinputamt
ratioonsubstitutiinput =
Input Price RatioInput Price Ratio
replacedinputprice
addedinputprice
ratiopriceinput =

7. Decision RuleDecision Rule
substitution ratio = price ratio
if substitution ratio is greater than the price
ratio ( SR>PR), the total cost of the feed ratio can be
reduced by moving to the next lower ration in the
table.
the least cost ration in this example is found bythe least cost ration in this example is found by
moving to ration F, where the substitution ratio ismoving to ration F, where the substitution ratio is
equal to the price ratio.equal to the price ratio.
SUBSTITUTION SHOULD CONTINUE UNTIL
SR = PR.

8. Choosing the least cost combinationChoosing the least cost combination
Feed ration for cattle to increase weight by 2 kg per week.Feed ration for cattle to increase weight by 2 kg per week.
Feed ration Hay (kg) Grain (kg) SR PRFeed ration Hay (kg) Grain (kg) SR PR
A 1350 825A 1350 825
2.93 1.472.93 1.47
B 1130 900B 1130 900
2.60 1.472.60 1.47
C 935 975C 935 975
2.20 1.472.20 1.47
D 770 1050D 770 1050
1.87 1.471.87 1.47
E 630 1125E 630 1125
1.47 1.471.47 1.47
F 520 1200F 520 1200
1.07 1.471.07 1.47
G 440 1275G 440 1275
Price of grain: RM 0.44 per kg Price of hay: RM 0.30 per kgPrice of grain: RM 0.44 per kg Price of hay: RM 0.30 per kg

9. Enterprise CombinationsEnterprise Combinations
Another decision that must be made
is the combination of enterprises
to produce to maximize profits. If one
or more inputs is limited, there is an
upper limit on how much can be
produced.

10. Enterprise RelationshipsEnterprise Relationships
The first step in determining the
profit-maximizing combination of
enterprises is to determine the
physical relationship among the
enterprises.

11. Types of RelationshipsTypes of Relationships
• Competitive productCompetitive product: the production from: the production from
one enterprise can be increased only byone enterprise can be increased only by
decreasing production from anotherdecreasing production from another
enterprise.enterprise.
• Supplementary productSupplementary product: more production: more production
from one enterprise can be added without afrom one enterprise can be added without a
change in the level of the other enterprise.change in the level of the other enterprise.
• Complementary productComplementary product: as production of one: as production of one
enterprise increases, production of the otherenterprise increases, production of the other
enterprise also increases.enterprise also increases.

12. Competitive EnterprisesCompetitive Enterprises
Competitive enterprises may have
constant substitution or increasing
substitution.

13. Production Possibility CurvesProduction Possibility Curves
for Competitive Enterprisesfor Competitive Enterprises

14. Output Substitution RatioOutput Substitution Ratio
gainedoutputofQuantity
lostoutputofQuantity
ratioonSubstituti =
Price ratioPrice ratio
lostoutputoficePr
gainedoutputoficePr
ratioicePr =

15. Decision RuleDecision Rule
output substitution ratio = output price ratio
If no available combination makes these
exactly equal, get as close as possible
without letting the price ratio drop below
the substitution ratio.
PROFIT IS MAXIMIZED at SR = PR, whenPROFIT IS MAXIMIZED at SR = PR, when
SR<PR, substitution should continue becauseSR<PR, substitution should continue because
additional incomeadditional income exceedsexceeds income lost i.e.income lost i.e.
substitution will increase total income.substitution will increase total income.

16. Choosing enterprise combinationChoosing enterprise combination
Selecting a profit maximizing enterprise combination with land the fixedSelecting a profit maximizing enterprise combination with land the fixed
input (the price of corn is RM 2.80/kg and the price of groundnut is RMinput (the price of corn is RM 2.80/kg and the price of groundnut is RM
4.00/kg)4.00/kg)
Combination Corn (kg) Groundnut (kg) SR PRCombination Corn (kg) Groundnut (kg) SR PR
1 0 60001 0 6000
0.20 0.700.20 0.70
2 2000 56002 2000 5600
0.30 0.700.30 0.70
3 4000 50003 4000 5000
0.45 0.700.45 0.70
4 6000 41004 6000 4100
0.55 0.700.55 0.70
5 8000 30005 8000 3000
0.70 0.700.70 0.70
6 10000 16006 10000 1600
0.80 0.700.80 0.70
7 12000 07 12000 0