- Law of diminishing return (law of variable proportion):
– This law states that keeping other factors fixed, upon increase in one variable factor marginal product initially increases and after that it declines and when variable factor becomes relatively abundant MPP becomes negative.
– This principle explains the input-output relationship.
– It helps managers in making decisions about how much to produce.
Three stages of this law:
a) Increasing marginal return
b) decreasing marginal return
c) negative marginal return
This law of diminishing return is mostly applicable in agriculture because of the following reasons:
a) Over-dependency of agriculture in weather conditions
b) There is less scope for mechanization in the agriculture sector mainly due to fragmentation problem in agricultural land.
c) There is less scope for division of labor.
d) There is the use of marginal and unproductive land in the case of agriculture.
e) Continuous cultivation in agricultural land.
- Principles of factor substitution:
– It is economical to substitute one resource (added resource) for another resource ( replaced resource) as long as the decrease in cost resulting from decreased use of replaced resource is more than the increase in cost resulting from increase in use of added resource.
i.e. decrease in cost > Increase in cost
Or ∆X2 × PX2 > ∆X1 × PX1
Or ∆X2 PX1
— > —
∆X1 PX2
– Thus we can say that it is economical to substitute one factor for another until the Marginal rate of technical substitution is greater than or equal to inverse price ratio. After that there incurs loss.
- Principle of product substitution:
– It deals with product-product relationship.
– It helps in determination of optimum product combination.
– Major goal of this law is profit maximization.
– This law guides farm manager in making decision about what to produce.
i.e. increasing in return > decrease in return
Or ∆Y1 × PY1 > ∆Y2 × PY2
Or ∆Y2 < PY1
— —
∆Y1 PY2
- Principle of equi-marginal return:
– Law of diminishing marginal return is applied when unlimited resources to find out the most profitable level of resource use.
– In reality, cultivator has limited land, irrigation and capital etc. There are several alternatives for spending limited amount of capital or money can be achieved by using the principle of equi-marginal returns.
– For eg: there is Rs. 50000 for investing and locality is favorable to take crop, dairy and poultry enterprise.
– The limited resources should be allocated among the alternative use in such a way that the MVP of the last unit of the resource is equal in all uses.
– Thus it can be stated that amount should be invested in such a way that marginal returns should be equal in all the alternatives.
- Opportunity cost:
– In agriculture resources are limited and have alternative uses. When resource is put to one use, opportunities of other alternatives are lost.
– OC refers to the value of the next best alternative forgone.
- Cost principle:
TC=FC+VC
Net revenue= TR-TC
– In the short run, gross revenue must cover the variable cost. Maximum net revenue is obtained when MC=MR.
– If the gross revenue is less than the total cost but greater than variable cost, guiding principle should be keep on production as long as MR is greater than MC.
– In short run, MC=MR point may be at the level of input use that may involve loss instead of profit. Yet at this point, loss will be minimized.
– For taking production decision on such a situation, one should go on using the resources as long as the added returns remain greater than the added total costs.
– Here the objective is to maximize the profit instead of minimizing losses.
- Time comparison principle:
There are two types of investments
a) Investment on operating inputs (seed, fertilizers, etc.)
b ) Investment in capital assets (land, farm building, machinery).
– Analysis of these investments involves not only comparison of costs and returns associated with it but also the timing of occurrence of costs and returns.
– The costs and returns from investment in operating resources occur with a production period of a year or less.
– The marginal principles are used to determine the optimum level of operating resources and no need to bring in time elements here.
– But in case of capital assets, where cost and returns are in different time periods and also capital expenditure involves costs and returns over time (eg orchards).
– To examine the profitability of these investments, requires recognition of time value of money.
- Principle of comparative advantage:
– Different location or region have different soil and climatic conditions so that differences in yield, cost, and returns while crops and livestock enterprises are raised that leads to the specialization in the production of the farm commodities by individual farmer or region.
– In this case, law of comparative advantage guides the producer for specialization of particular commodity in particular location based on the economic advantages (relative yield, cost and return are the criteria).
There are two types of advantages in the production of farm commodities:
a) Absolute advantage:
– It is the size of the margin or difference between the cost and return from using productive input.
– If the margin is larger for one farm commodity in one region then that region has absolute advantage in producing that commodity.
b) Comparative advantage:
– A region may have more absolute advantages for more than one commodity but a farmer should specialize in that commodity which have more return per unit of investment among all other alternatives.
-Also comparative advantage occurs when one country can produce a good or services at a lower opportunity cost than another.
– It occurs due to differential productivity and scarcity of land, labor and capital.
– This means a country can produce a good relatively cheaper than other country or region.
– Theory of comparative advantage states if country specialize in producing goods where they have a lower opportunity cost then there will be increase in economic welfare.
