This article throws light upon the seven economic principles that strengthen managerial ability of the farm manager. The principles are: 1. The Law of Diminishing Marginal return or Law of Variable Proportion 2. The Law of Equi-marginal Relationship 3. The Law of Opportunity Cost 4. The Law of Substitution 5. The Principles of Comparative Advantages 6. Principles of Combining Enterprises 7. Cost Concepts and Cost Principles.
Economic Principle # 1. The Law of Diminishing Marginal Return or Law of Variable Proportion:
This is the factor-product relationship—the F/P relationship is the production function which means how the inputs used affect the output.
It has two F/P relationship:
(a) Proportionality relationship. Y = f(X1, X2…………………….. Xn).
(b) Scale relationship.
When all inputs are increased simultaneously:
(i) Increasing return to scale,
(ii) Constant return to scale,
(iii) Diminishing return to scale.
Economic Principle # 2. The Law of Equi-Marginal Relationship:
The law concerns the budget allocation to different enterprises for the maximization of profit also optimization of profit. Here the fund is allocated to different enterprises in a manner that the last unit of each enterprise gives the equal return.
Here it may be noted that units of funds allocated to different enterprises may vary. In this manner the total profit stands maximized. The F/F and P/P relationship together lead to profit maximization.
Economic Principle # 3. The Law of Opportunity Cost:
This law tells us that when there resource constraint or budgetary constraint the resource should be used in the enterprise which gives the maximum return, that is, the opportunity to invest in that enterprise is the best. This also deals with the optimization of output.
Economic Principle # 4. The Law of Substitution:
In this law the condition is the factors of production or the input and the product should be substitutable.
The law is concerned with:
(a) Concept of elasticity;
(b) Concept of substitution;
(c) Law of diminishing substitutability.
There are two types of relationships:
(i) Factor-Factor relationship—Least cost relationship—Cost minimization.
(ii) Product-Product relationship.
The substitutability is in accordance to their relative prices, for example, chemical fertilizer and organic manners are substitute for each other. Either one of the, fertilizer or manure, will be singly applied to get the output or a combination of the two.
In the former case if one is cheaper than the other the cheaper will be used. In the later case (two combined) the combination will depend on the marginal rate of substitution (MRS) and the price ratio of the two inputs. The proportion in which both will be combined shall be when MRS = Price ratio.
Economic Principle # 5. The Principles of Comparative Advantages:
The farmers are interested in the maximum net profit he should grow only those crops which may give maximum return. For example, in one hectare of land in Rabi season, the farmer can raise either wheat or potato.
Since potato gives greater net profit over wheat he should prepare to put the land under potato (here we are ignoring the higher risk involved in the cultivation of potato). That is, potato cultivation has a comparative advantage over wheat cultivation.
Economic Principle # 6. Principles of Combining Enterprises:
The wisdom of farmer lies in cultivation of several crops or enterprises for the sake of getting a regular income, minimization of risk, and maximization of income within the available but limited resources.
There are certain relationship between the enterprises:
(a) Main Enterprise:
A single enterprise raised on the larger area of the farm. Like Paddy in Kharif season, Wheat in Rabi season.
(b) Complementary Enterprise:
These enterprises are the one in which case the forerunner enterprise is beneficial to the enterprise following it. For example, if in the kharif season leguminous crop is raised and in the Rabi season wheat is cultivated in the same land, the wheat crop will be benefited because the leguminous crop has added fertility in the land from which the wheat crop gets benefit and the yield is higher.
(c) Supplementary Relationship:
In this relationship some more income is generated on the farm besides what is obtained by the main enterprise without adversely affecting the main enterprise. For example, a farmer is left with some money and he has sufficient leisurely time which he could devote to another enterprise like keeping some fowl on the farm.
The return from the poultry will add to his income without telling upon the crop enterprises. But if the scale of operation is increased then it will take the shape of competition in terms of resources viz. money and time.
(d) Competitive Enterprises:
Here the enterprise compete for the resources. For instance, in Rabi season the farmer can devote one hectare of land either to the cultivation of wheat or potato. He has got limited resources viz., land, labour in man days, and capital (money).
Here both the enterprises will compete for the resources. As a consequence of the competition there will be combination of enterprises on the basis of “linear programming” or principles of opportunity cost or comparative advantage will be resorted to.
In combination of enterprises we have to keep in mind:
(i) Physical factors.
(ii) Economic considerations.
Nature of Enterprise Relationship:
If complementary or supplementary the increasing area will be thought of. If competitive then:
(a) Price ratio of the products;
(b) Substitution ratio of the product;
(c) Per unit cost of production:
(i) If cost of production is equal then selling price is considered.
(ii) If unequal is the cost of production then cost price = net price.
Economic Principle # 7. Cost Concepts and Cost Principles:
This is an important principle in deciding to make investment and helps the farm manager as to how to make investments. This also helps up-to what extent the investment should be made in an enterprise.
There are two main costs viz.,
(1) Fixed Cost:
This cost is there whatever may be the level of production but it can be reduced on per unit basis if the scale of production is increased.
(2) Variable Cost:
This cost varies with the level of production. This classification is for the short run but in the long run the total cost becomes variable cost.
Together these costs make total cost. Again, these costs are further divided into: Average fixed cost, average variable cost, average total cost and marginal cost. In all there are seven costs.
Cost concepts in relation to decision making: These are: Cost A1, Cost A2, Cost B, and Cost C.
Cost A1 includes:
(a) Explicit cost:
This comprises of: wages of hired labour, bullock labour (hired or owned or both), value of seed, manures, fertilizers, plant protection, irrigation charges and revenue.
(b) Implicit Cost:
Interest on development loans, depreciation on fixed capital. Cost A2 includes Cost A, plus rent paid for the land. Cost B includes Cost A2 plus rental value of owned land and interest on owned capital (including land) and interest on working capital. Cost C includes Cost B and imputed value of family labour. This is the commercial cost of production.
The theoretical concepts of costs are in terms of:
(a) Short Run Cost:
In which the price is equal to marginal cost, Price = MC.
(b) Long Run-Cost:
The price is equal to sum of prime cost, supplementary cost and risk cost to cover unfavorable yields and unfavorable price possibilities.
Under the managerial decision-making process, the present and future costs have to play their significant role.
These principles are:
1. Compounding Cost,
2. Discounting Cost,
3. Present Worth over time.
1. Compounding Cost:
Here the present cost is made to grow over time to make it comparable to future returns.
This is expressed through an equation:
A = (1 + r)n
where, A = the compound value of present cost ‘C’;
r = rate of compound interest per rupee;
n = number of years.
2. Discounting Cost:
Future revenue could be discounted back to present. It helps to compare the present worth of the future revenue with the present investments. If the present worth of the future revenue is less than the investment, it would be unwise to invest the money in resource service to get the future revenue at the end of a certain number of years.
The formula is:
PW = Present worth;
R = Future revenue;
r = rate of interest per annum;
n = the number of years.