Assuming the price of fertiliser is $2000 per tonne ($2 per kg) and the price of wheat
is $200 per tonne and assume fixed costs are $10/ha,
a) how do the graph in shot 1 relate to production function?
b) Briefly explain the meaning of each of the curves in shot 2.
c) Calculate the most profitable, the least cost quantity of fertiliser to use and the
corresponding quantity of wheat to produce. Illusrate this on graph shot 2 and explain
what the calculations mean.
d) Explain why and under what conditions it is rational for a farmer to produce a product at a loss.
Please note that we ask eNotes users to submit one question at a time. Here, you are presenting us with what are essentially four questions. I will answer questions B and D since they are clearly related to one another. If you wish to have more questions answered, please put them in separate questions.
In Shot 2, you have six curves. The AFC curve is average fixed costs. This takes your fixed costs and divides them by the output. This is why the curve goes down. The AVC is your average variable costs. These are your costs for fertilizer (and possibly other things like labor that are not discussed in your question) divided by output. The ATC curve is the average total cost curve. To get this you add the average variable cost to the average fixed cost and divide that total by the output. The MC curve is for marginal costs. This shows how much it costs you to make the next unit of output. The AR curve is the average revenue. It takes the money you have earned and divides it by the total output. Finally, the MR curve is the marginal revenue curve. That is the amount of revenue you get for selling the last unit of input.
It is rational for the farmer to produce a product at loss as long as the marginal revenue is higher than the average variable costs. The farmer will still be losing money, but they will not lose as much as they would be shutting down. A farmer who continues to produce will be able to pay for the fixed costs and some of the variable costs. The farmer who shuts down will get no income but will still have to pay the fixed costs. Therefore, it is better to keep producing, even if you are losing money, so long as your marginal revenue is higher than your average variable costs.