Course Code: AEC-502 (Elementary Production Economics)

Teacher: Dr. Nasir Mahmood

Submitted by: Moazzam Ali

Arid no.: 18-ARID-2040

Section: A

Bsc(hons) agricultural economics

Assignment # 1

Q no. 1 Discuss the role of microeconomics versus macroeconomics in agricultural economics.

Does microeconomics have a greater impact than macroeconomics on the farm manager?

Explain.

Answer:-

Microeconomics versus Macroeconomics:-

Economics can be broadly divided into two categories: microeconomics and

macroeconomics. Microeconomics is concerned with the behavior of individual decision-

making units. The prefix micro- is often used in conjunction with things that are small.

Microeconomics deals with the behavior of the individual consumer as income is allocated and

the individual firm manager (such as a farmer) who attempts to allocate his or her resources

consistent with his or her goals.

The prefix macro- is often used in conjunction with things that are large.

Macroeconomics deals with the big picture. For example, a person studying macroeconomics

might deal with issues confronting an entire economy. Inflation and unemployment are

classical areas of concern for macroeconomists. They are concerned with how producers and

consumers interact in total in a society, nation, or for that matter, the world.

Macroeconomists are also concerned with the role that government policy might play in

determining answers to the fundamental questions that must be answered by any society.

These questions include (1) What should be produced? (2) How much should be produced?
(3) How should available goods and services be allocated?

Although microeconomics and macroeconomics are often considered to be separate

branches of economics, they are really very closely intertwined. The macroeconomy is made

up of individual producers and consumers. Moreover, the decisions made by individual

producers and consumers are not at all independent of what is happening at the macro level.

Tax cuts and tax increases by the federal government influence income available to the

individual consumer to spend. Prices received by individual farmers for the commodities they

produce are in large measure determined by the aggregate production of all farmers in

producing a particular commodity, yet to a great extent affect decisions made by the farmer

as an individual firm manager.

This text deals with production economics and the central focus is on the farm firm as

an individual decision-making unit. At the same time, the individual farm firm does not

operate in a vacuum, but is affected in large measure by what happens in the aggregate. Moreover,
decisions made by individual firms such as farms, when taken together, can have

a substantial impact in a macroeconomic setting.

Q.no 2 If pure competition is not an adequate representation of the economic model that underlies

farming in the United States, why do the assumptions of pure competition continue to be

important to agricultural economists?

Answer:-

The Assumptions of Pure Competition

Economists often use the theory of pure competition as a basic model for explaining the

behavior of firms in an industry. At this point, it is useful to review the assumptions of the

classical economic model of pure competition and assess the degree to which these

assumptions might apply to farming in the United States. The model of pure competition

assumes the following.

A large number of buyers and sellers in the industry exist. Few would feel that there

are not a large number of sellers in farming. The United States Department of Agriculture
(USDA) reported over 2.4 million farms in the United States in 1980, but farm numbers are

far fewer for selected agricultural commodities. Only a few farms supply the entire nation's

parsley needs, for example.

The assumption of a large number of buyers may be met to a degree at a local livestock

auction market or at a central grain exchange in Minneapolis or Chicago, but many

agricultural products move in markets in which only a comparatively few buyers exist. The

tobacco producer may face only buyers from the three or four major cigarette manufacturers, and
prices are determined in an environment that is not very competitive. In the livestock

sector, broiler production has been dominated in recent years by only a few major producers.

Production of hogs and cattle in the United States is often closer to a purely competitive

environment in which a large number of farm firms take prices generated by overall supply

and demand for hogs and cattle. However, there are a relatively small number of buyers for

hogs and cattle, which again means that the model of pure competition does not strictly apply.

The firm can sell as much as it wants at the going market price, and no single firm is

large enough to influence the price for the commodity being produced. For many agri-

cultural commodities, the farmer can sell as much as he or she wants at the market price.

Farmers are price takers, not price setters, in the production of commodities such as wheat,

corn, beef, and pork. However, for certain commodities, the sparcity of farms means that the

producers might exert a degree of control over the price obtained.

The product is homogeneous. The homogeneity assumption implies that the product

produced by all firms in the industry is identical. As a result, there is no need for advertising,

for there is nothing to distinguish the output of one firm from another. For the most part, this

assumption is true in farming. There is little to distinguish one producer's number 2 corn from

another's number 2 corn. For a few commodities, there have been some attempts at product

differentiation!for example, Sunkist oranges by the growers' cooperative, and branded

chicken by the individual broiler producer.

There is free entry and exit, and thus free mobility of resources (inputs or factors of
production) exists both in and out of farming. The free-mobility assumption is currently

seldom met in agriculture. At one time it may have been possible for a farmer to begin with

very little money and a lot of ambition. Nowadays, a normal farm may very well be a business

with a million dollar investment. It is difficult to see how free entry end exit can exist in an

industry that may require an individual firm to have a million dollars in startup capital.

Inflation over the past decade has drastically increased the startup capital requirements for

farming, with resultant impacts on the mobility of resources.

Free mobility of resources in linked to an absence of artificial restraints, such as

government involvement. There exist a number of artificial restraints in farming. The federal

government has been and continues to be involved in influencing production decisions with

respect to nearly every major agricultural commodity and numerous minor commodities as

well. Agricultural cooperatives have had a significant impact on production levels for

commodities such as milk and oranges.

Grain production in the United States is often heavily influenced by the presence of

government programs. The wheat and feed grain programs are major examples. In milk

production, the government has largely determined the prices to be received by dairy farmers.

The government is involved not only in major agricultural commodities, but is also

heavily involved in the economic environment for many commodities with limited production.

For example, the hops producer in Washington state, or the burley tobacco producer in central

Kentucky, produces in an environment in which the federal government largely determines

both who will produce as well as how much each grower will produce. This is anything but

competitive.

All variables of concern to the producer and the consumer are known with certainty.

Some economists distinguish between pure competition and perfect competition. These

economists argue that pure competition can exist even if all variables are not known with

certainty to the producer and consumer. However, perfect competition will exist only if theproducer
knows not only the prices for which outputs will be sold, but also the prices for

inputs. Moreover, with perfect competition, the consumer has complete knowledge with
respect to prices.

Most importantly, with perfect competition the producer is assumed to have complete

knowledge of the production process or function that transforms inputs or resources into

outputs or commodities. Nature is assumed not to vary from year to year. Of course, this

assumption is violated in agriculture. The vagaries of nature enter into nearly everything a

farmer does, and influence not only output levels, but the quantity of inputs used as well.

Why Retain the Purely Competitive Model?

As has been indicated, the assumptions of the purely competitive model are not very

closely met by farming in the United States The next logical question is: Why retain it? The

answer to this question is simple. Despite its weaknesses, the purely competitive model comes

closer to representing farming than any other comprehensive model of economic behavior. An

individual farm is clearly not a monopoly if a monopoly is thought of as being a model in

which a single firm is the industry. Nor, for most commodities, do farmers constitute an

oligopoly, if an oligopoly is defined as a model in which only a few firms exist in a

competitive environment where price and output decisions by one firm a strongly affected by

the price and output decisions of other firms. Nor does farming usually meet the basic

assumption of monopolistic competition, where slight differences in product prices can be

maintained over the long term because individual producers are somewhat successful in

slightly differentiating their product from products made by a rival firm.

In summary, the purely competitive model has been retained as the basic model for

application within agricultural production economics to farming because it comes closer than

any of the remaining models of competitive behavior. This does not mean that other models

of competitive behavior are unimportant in the remainder of the text. Rather, reliance will be

placed on the purely competitive model as the starting point for much of our analysis, with

modifications made as needed to meet the particular features of the problem.

Q no. 3 Nowadays, is mathematics essential for understanding economic principles?

Economic theories and models can be represented in a variety of ways. Beginning in the

18th century with Adam Smith's famous work The Wealth of Nations, economists have relied

heavily on words to express economic relationships. Increasingly, words did not lend

themselves very well to answering specific "what if" types of questions. Economists in the late

nineteenth and early twentieth centuries relied increasingly on graphical tools as the major

means of expressing economic relationships. Graphics could often be used to make complex

verbal arguments precise, but graphical tools had disadvantages as well. For example, a graph

representing a production function on a farm was limited to no more than two inputs and a

single output, since it is not possible to draw in more than three dimensions.

The use of mathematics as the means of describing economic theories and models got an

important boost with the publication of Paul Samuelson's Foundations of Economic Analysis

in 1947. Since that time, mathematics has become increasingly important as a tool for the

development of theory and models. Fuzzy relationships cannot be part of a theory posed in

mathematical terms. Moreover, mathematics opened new doors for expressing complicated

relationships. On the production side, there were no longer any limits as to the number of

inputs that a production function might use or the number of outputs that could be obtained.

Concomitant with the increased use of mathematics for describing economic relationships

was increased use of statistics for estimating economic relationships from real world data. An

entirely new subdiscipline, econometrics—economic measurement—appeared. The

relationships contained within the mathematically based theoretical model could now be

measured.

The final event having an impact on economics over the second half of the twentieth

century was the rapid growth in the use of the computer as a device for estimating or

measuring relationships within an economy. Economists now routinely use techniques for

estimating models in which the computational requirements would have been considered

impossible to achieve only five or ten years ago.