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O ooR

Peter E. Hildebrand
Agricultural Economics










PROCEDURAL GUIDEBOOK FOR PRODUCTION ECONOMICS

RESEARCH CONTRIBUTING TO GP-5











PROCEDURAL GUIDEBOOK FOR PRODUCTION ECONOMICS
RESEARCH CONTRIBUTING TO GP-5


A. INTRODUCTION

At the October 1962 meeting of GP-5, the production research subcommittee

established a methodology committee charged with the responsibility of develop-

ing some guidelines for production research. 1/

This guidebook is to be considered as the report of this subcommittee and

is to be considered as tentative until approved and adopted by the production

subcommittee as a whole.

In the preparation of this guidebook, it was assumed that additions to

this report will be made at future dates when necessary. Some types of possible

research on adjustments on wheat farms have only been touched upon. These topics

can be developed at a later date when it becomes possible to do this type of

research.

The purpose of this guidebook is not to "tie the hands" of the individual

research worker, but to guide him. In such regional effort, uniformity in

approach is necessary if the regional objectives are to be fulfilled. Objective

A of the regional statement contains the following statements:

"The overall purpose of this project is to provide information and
guides to farmers, other businessmen, institutions, the public and
governmental policy makers and administrators to the end that planned
adjustments in private and public affairs will be as consistent as
possible with present and fgFW economic and technological
conditions and private and public objectives."



1/ Appointed at that time were Odell Walker, Peter Hildebrand, and
Ronald Krenz, Chairman.







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Point 3 of the specific objectives reads as follows:

"To determine the effect upon total agricultural production, farm
income, farm organization, and resources employed in the Great
Plains if selected percentages of all farmers adjust to their most
profitable farming systems for various assumed product demand
conditions, factor supply conditions and specific agricultural
programs and institutional arrangements."

Successful completion of these objectives will require close cooperation of

all individual research efforts.

Although the regional project statement does not specify the procedures that

will be used, further examination of the regional statement will help to point out

the direction we may take. The specific objectives, numbers 1 and 2 under Objec-

tive A, read as follows:

1. To develop information on technical production relationships and
opportunities for grain farms in the Great Plains.

2. To determine the nature and magnitude of adjustments needed in
specific farm situations which will achieve the most profitable
systems of farming under a range of conditions with respect to
prices of major products and quantities of available resources such
as land, labor and capital and to determine the quantities of
resources required to provide selected levels of farm income.

Regardless of the models (or the priority of models) chosen to provide inform-

ation suited to the general objective A, objective 1 (above) must be realized.

Thus, the first priority or procedural step appears well defined. Suggested

procedures for objective 1 are presented later in this handbook.

Objectives 2 and 3 are designed to provide information for farm firms, other

business firms and for governmental decision makers. Alternative techniques for

obtaining different but related types of needed information might include the

following:

1. Individual Firm Analyses
a. Profit maximization models and optimum firm supply function
derivation, including as subroutines selected combinations of:
(1) alternative governmental programs
(2) alternative assumptions about firms' responses to price variation
(3) alternative length of run and, thus, alternative resource
fixity assumptions









(4) alternative prices and supplies of variable inputs such as
labor and capital
Analyses of size or scale relationships obtained in programs with
different combinations of assumptions in (3) and (4) would also be
useful.

b. Minimum resource models to estimate resources needed to obtain
specified income levels and possible area adjustments in size and
number of firms. (specific subroutines applied here might include
(1), (4) and (5) (above) plus alternative land prices, product
prices and demand constraints).

2. Regional analyses
a. alternative aggregations and analyses of results from individual firms
studies (a & b)

b. Regional cost minimization and/or profit maximization models in which
area responses are obtained and used, including as subroutines:
(1) alternative marketing organizations
(2) alternative transportation charges
(3) alternative exogenous conditions with respect to:
(a) National demand for products of interest
(b) Government commodity programs
(c) Alternative net foreign demand
(d) Supply conditions outside the area

c. "Rough and ready" partial equilibrium analyses in which supply
functions for areas within the Great Plains are confronted with
alternative net Great Plains demand functions.

This is not an exhaustive listing but it does indicate that some selection

of methods is possible. This also indicates that there may be differences in

opinion in regard to the procedures which individual workers may wish to use.

Each procedure has certain limitations and advantages but it is hoped that

eventually each procedure which has merit may be used at some stage in the GP-5

work. It is a proposal of this subcommittee that the GP-5 committee adopt

certain minimum goals which all states, which have contributing projects, must

attain. Work beyond these minimum goals is encouraged. However, to achieve our

research objectives unified and concerted effort must be made.


B. PROCEDURE

I. Development of Production Possibility (Input-Output) Data

As stated earlier, a necessary step in production research on objectives







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cited is development of physical and economic data on production alternatives

for cash-grain farms in the Great Plains. Suggested procedures for assembling

these data are provided in this section.

a. Area deliniation Relatively homogeneous areas, with respect to

aggregative response to economic and institutional stimuli, will be the smallest

unit directly considered in regional type models. All major cash-grain farming

areas in Great Plains States would be studied. Small "pockets" of cash-grain

farming may be excluded initially, along with range situations, and later in-

cluded in aggregations as budgeted additions. State workers would have responsi-

bility for choice of areas. However, coordination and cooperation with other

state workers having the same areas could be achieved.

b. Enterprise Selection The enterprises to be studied in any adjustment

area are, of course, determined by the production possibilities in that area.

However a few suggestions are here offered.

1. Each state should endeavor to carry out a complete analysis of

the farm opportunities in each adjustment area. That is, if some type of live-

stock production is possible in the area, it should be considered as long as

it competes for on-farm resources. In some adjustment studies of this type,

only "land-using" livestock enterprises were considered. This procedure only

avoids the problems involved and does not answer them. Classification of live-

stock on the basis of land use is quite arbitrary and, of course, other resources

may be of equal or greater importance in determining the necessary farm adjust-

ments.

2. Since we are looking to the future the enterprises to be included

should not necessarily be limited to those enterprises now found on farms. Consid-

eration should be given to new enterprises which show promise for the future.






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3. Some consideration should be given to the selection of enterprises

on the basis of personal preference and managerial capabilities of producers

in the area. If this is done the programming results will be more predictive

and also more acceptable to producers.

c. Selection of input-output data As stated earlier, the coefficients

we use should be based on estimated future production techniques. Hence it

is the suggestion of this committee that the coefficients be based on production

techniques which 50 percent of the farmers will be using in 5 or 10 years. This

might be regarded as above-average management at the present time. This committee

does not insist on this assumption but regards it essential that the same

assumption be used in all state studies.

The individual research worker will, of course, use all available sources

in deriving the input-output data. If the coefficients are to be based on

future production techniques some time will necessarily be spent conferring with

specialists in particular fields of research and in studying the results of

experiment research. Experimental research which has been designed through

joint efforts of economists and plant or animal scientists will generally be

good sources for answering questions on production function type questions where

a wide variety of input-output combinations are possible. Engineering sources

are useful when trying to select machinery inventories or with farm building

problems.

Crop and livestock reporting estimates must be utilized in estimating such

items as rates of abandonment of crops, trends in yields and in tying experi-

mental results to actual yields and cropping practices.

The on-farm source cannot be ignored. Farmers are perhaps the best source

of information on tillage practices, rates of seeding, labor requirements, repair

and maintenance costs and other cash-cost items. The typical farm management

survey schedule offers much valuable information but in many cases may be






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quite expensive. Some research workers have found group survey methods to be

less expensive and more reliable.

It is the desire of this committee that the contributing projects use

uniform assumptions in deriving their input-output data and establishing their

enterprise budgets. Hence the following basic assumptions are proposed:

1. Land tenure Assume the local prevailing tenure for cropland and

noncropland. This may be full ownership in some areas or share

or cash leasing or leasing of public lands.

2. Expense items Items to be included as expenses include:

A. Interest charges at the 196, average rate in each area on

average investment in machinery and new buildings and on

required operating capital. Interest on operating capital

should be adjusted on the basis of the length of time the

operating capital is used and on the basis of frequency of

sales. For example, with dairy cows little, if any, interest

charge on working capital would be needed. Interest on land

investments need not be included in determining production

costs if land is to be considered as a fixed factor. When

determining net farm income such interest charges can be

included.

B. Depreciation and repair of farm machinery and other necessary

equipment. Rates are to be based on actual use in the area.

It has been found that in many areas smaller farms use old

machinery. However, on many small farms the machinery invest-

ment is lower than the amount which would be necessary for

continued operation. The machinery inventory is low simply

because the operator does not plan to continue operation but

plans to retire soon. This factor should be examined in setting









up machinery inventories for small farms.

C. Personal property taxes and customary levels of insurance.

Again, if farmland is a fixed factor, land taxes need not be

included in production costs.

3. Labor costs Hired labor should be charged at projected average

levels for the area. Whether or not operator's labor should be

charged is debatable. Without an assigned opportunity cost to

labor, labor will be allocated at a "zero" cost in linear programming.

The assumption of "zero" opportunity cost is often the reason why

optimal plans are obtained that farmers will not accept or adopt.

On the other hand, the determination of the proper opportunity

charge is quite difficult. To be correct, this charge should vary

between individuals.

4. All other operating expenses such as seed, fertilizer, chemicals, fuel,

lubrication, etc. should be charged at the projected rate of use for

above average management and at projected average price levels.



I. Individual Firm Analysis

The profit maximizing model is given primary attention in this section.

When necessary, other models can be added in additional sections.

A. Profit maximizing models The procedures to be used in individual firm

analysis are outlined below. In each of the following steps many decisions will

need to be made by the individual research worker. Hence, a clear decision must

first be made by the committee on the goals we are trying to attain and the

purposes of our work. If these goals are explicit, much less confusion will arise

as the work proceeds.








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Based on the regional project statement, at the individual firm level

we want to be able to give advice to farm managers on the types of adjust-

ments that are needed and how to make these adjustments. This implies a goal-

attainment approach. In other words, we are trying to identify a gap between

the present situation and some "more desirable" situation. Just how this "more

desirable" situation is to be defined is subject to question. The use of the

term "profit maximization" does not satisfy these needs and requires further

elucidation. In this case we are comparing the present situation on a farm

with what could be attained in the way of income to the farmer and returns to

his resources under specific farm programs. Since the farmer's alternatives

are limited by his managerial capacity, his asset position, certain fixed

investments and by other factors, we can only try to tell him how to maximize

his profits within these given constraints. This is really only an attempt to

define the length of run we wish to examine.

From the standpoint of the individual farmer, we may want to examine the

possible adjustments that can be made given various lengths of time for adjust-

ments. We may want to determine the adjustments which can be put into effect

within one or two production periods and also those adjustments which require

more time. It is the suggestion of this committee that optimal plans first be

obtained under the assumption that a period of 5 to 10 years is allowed for on-

farm adjustments. This implies that machinery investments can be changed from

the present situation to reflect changes in technology. Livestock buildings ca

be added to or remodeled to fit the livestock needs.

It is also suggested that three categories of capital be considered; annual

or operating capital, intermediate capital for the purchase of equipment and

livestock for breeding, and longer-run capital for the purpose of purchasing land

and construction of new buildings. Such classification will make it possible to

adjust the length of run using the same model and hence would make it feasible

to consider the purchase of land.









For the sake of public-policy decision making (and individual decision

making), our suggestions must be forward looking. Since our results will not

be available for some length of time, they should be based on estimated future

production techniques.

From the viewpoint of public-policy decision making, any aggregation of

the results for individual firms should consider some of the equilibrium problems.

Each farm cannot be studied in isolation. The aggregative results must add

up to make reasonable sense. Hence, considerable care is needed in our assumptions

regarding farm input and product prices.

The above can be summarized as follows:

1. In the procedures, consideration needs to be given to personal

desires and personal abilities, especially regarding the selection

of enterprises.

2. Consideration needs to be given for fixed farm resources and farm

assets.

3. Consistent assumptions need to be made in regard to length-of-run.

4. Price assumptions are needed which will give sensible aggregation

totals.


1. Classification of farms Probably the first task in this type of

analysis is to classify the farms in an area into meaningful groups. The purpose

of this classification is to group together those farms which will respond

or react in like manner to given stimuli. In subsequent steps of the analysis,

one may find that the original classification was incorrect. Additional sub-

classification may be necessary, or farms of some strata can be grouped and

analyzed together.

Farms are generally classified according to factors which limit production

such as the resources available and the production possibilities of the farms

and factors which limit adjustments. However it is impossible to prepare an






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exhaustive list of the criteria one might use for classification. The criteria

that should be used are determined by those factors which will influence the

optimal plan. For instance, if farms with different soil types will respond

differently to a given stimulus, then soil type should be a basis for classifi-

cation. If this difference in soils will not cause a difference in responses,

then soils need not be considered in the classification of farms.

In the Great Plains states, farms could be classified on the basis of any

of the following:

1. Cropland acreage

2. Noncropland acreage

3. Size of wheat allotment

4. Size of feed-grain base

5. Soil type

6. Climatic or rainfall zone

7. Capacity of fixed assets such as livestock buildings

8. Supply of seasonal labor

9. Supply of operating capital

10. Land tenure


Classification of farms on the basis of tillable acres is generally necessary

due to the variation in operating costs by size of farm. Also wheat and feed-

grain allotments vary within any size group of farms due to past farming practices.

Such classifications would probably not be needed under the assumptions of free

markets. The other factors listed generally affect yields and/or type of

enterprises which would be considered in the farm model.

Items 3, 5, and 6, and to some extent 2, will be accounted for in area

deliniation. Thus, the number of factors considered in classifying farms can

be reduced.






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It is obvious that the number of strata increases rapidly as more factors

are used in classifying farms. The goal of this classification is precision in

the final estimates, but on the other hand intensive classification increases costs

through increasing the need for more input-output data, for more computer time,

and through increasing the problems of aggregation. It is not necessary that all

states contributing to a regional aggregation effort classify their farms to the

same degree of intensity; however, for aggregation purposes it is necessary to

know the number of farms within each group of strata. Hence the classification

of farms in any state must be based on (1) the resource factors which will

affect production responses to given stimuli, (2) the availability of data, and

(3) the costs of the classification and subsequent analysis as compared to the

research budget. 2/

2. Commodity programs and product price assumptions In studying farm

adjustments, we must know what we are trying to adjust to in terms of prices and

product demands. Since uncertainty about future market conditions and govern-

mental programs prevails several alternative assumptions should be examined. This

committee suggests the following sets of programs be adopted as minimum goals in

the priority listed.

a. A no government program restrictions--no support situation, with price

situation as follows:

Feed-Grains and Livestock Prices 1959-62 Wheat Support Price at the Farm Level
$1.00 Corn and (Price
Average 1950-62 L.S. Price Levels) 50% 75% 100% 125% 150%

50% or 75%

at: 100%

125%-150%


2/ For further references see "Farm Size and Output Research," Southern
Cooperative Series No. 56, pages 32-46, June 1958 and "Farm Characteristics for
North Dakota by Economic Area," Agr. Econ. Rept. No. 23, Dept. of Agr. Economics,
N. Dak. Agr. Expt. Sta., June 1962.







-12-

b. The 1964 wheat and feed-grain programs

c. The 1963 wheat and feed-grain programs

d. The 1962 wheat and feed-grain programs

Priority is given to "no program" because aggregate responses to other

programs (b, c and d) can be deduced partially from this situation with varying

prices. More general ways of specifying programs might be devised in terms of

total national allotments, historical allocations of allotments and "equilibrium"

prices for allotment levels and governmental objectives.

Many other programs could be included in this list but these would seem

to have priority. The no-program assumption was included due to the possibility

of rejection of other wheat programs in a wheat referendum and because much inform-

ation can be learned about the comparative returns of various farm enterprises

through varying the price of wheat.

Many of the specifications of these programs need further discussion and

a complete memo needs to be prepared for each program. These program memos

should include price assumptions for other crops and for livestock. These price

assumptions should be included in the program memos since they may vary with

the wheat and feed-grain programs.

3. Input supplies and prices Assumptions about supplies of capital and

labor should conform to usual farm (resource situation) conditions in a given

area. However, a minimum of two interest charges should be utilized. The

committee needs to make decisions regarding available operator labor assumptions

for, say, management time and field labor time.

4. Size and scale relationships will be accounted for in enterprise

budgets and in whole farm programs. For example, existing resource situations

of "small" sizes would require input-output information involving higher labor

requirements per unit of, say, cattle and small equipment. Custom rates in jobs

frequently hired may be used.






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5. Budgeting and linear programming Either budgeting or linear programming

will be used in determining the on-farm adjustments. While either method may

be used, linear programming has several distinct advantages. For an individual

who is familiar with programming, it is much quicker than budgeting. Programming

also provides information which is not possible to obtain with budgeting procedures.

Programming can also show the proper strategies to follow in maximizing profits on

a group of farms. These strategies can then often be used in further budgeting

of these or other model farms. In the interpretation of programming results, some

small enterprises may need to be eliminated and other enterprises rounded off

to give sensible answers. Thus a combination of linear programming followed by

budgeting is often the most expedient.

There is little need to outline in detail the linear programming models.

They will be straight-forward profit maximizing models in almost every case. The

number of equations and activities will, of course, vary with the area. Many

well-known references are available on linear programming and need not be listed

here.

B. Minimum Resource Model A minimum of one model designed to estimate

resources required to earn one selected level of income is recommended for each

area. Assumptions regarding most probable long-run conditions with regard to

prices of products and factors and governmental programs will need to be chosen

by the committee and modified by state workers to suit local conditions.

II. Regional Analysis Introductory Remarks

Regional analysis differs from an aggregation of optimum firm adjustments

in several important aspects. First, aggregate supply adjustments and adjust-

ments in optimal resource use for an area are considered directly and more

adequately in a regional model than in an aggregation of firm responses. 3/

3/ The most notable exception is the effect on supply response (stickiness
in adjustment) caused by resource fixity. This effect must be estimated in a
regional model, but can be considered directly in a firm analysis.







-14-

In a regional model, equilibrium prices are determined -- these can only be

guessed in a model composed of firm aggregation.

In addition to giving the regional location of commodity production, given

the distribution of consumption centers, regional analysis is capable of produc-

ing much information which is not available with an aggregated firm analysis. One

of the more useful of these is a measure of the sensitivity of all cost coefficient,

used in the model. Y/ Estimates of the sensitivity of all cost coefficients

appearing in the final solution are found by the cost ranging solution available

in several linear programming routines. Further refinement in the cost estimates

for those areas or regions whose cost coefficients have a wide range (low

sensitivity) would yield little additional accuracy in the model. In those cases

where the range of costs over which the solution is stable are quite narrow,

further refinements in cost data are indicated. This knowledge could aid in the

allocation of research funds for data procurement.

Sensitivity of the estimates of the restrictions in the model can be determined

in much the same way from many linear programming procedures (right-hand side,

or resource vector, ranging solutions). If the range of error allowable for the

estimated size of the restriction is quite large, time spent in refining this

estimate would be of little value. On the other hand, in those cases where

the range is narrow, further refinement is indicated. 5/

Additional information which can be obtained from a linear programming

solution to a regional model includes the cost to the model of allocating produc-

tion to areas which are not included in the optimum solution. Thus, if it is

estimated that a certain area will produce some quantity of a commodity regardless

4/ In firm analysis cost ranges can also be obtained, but these will be
limited to production activities and reflect only the effect of cost on the firm
organization and not the regional organization,

5/ The same statement applies here as in the case of cost ranges. However,
the meaning attached to RHS ranging solutions in a regional model is considerably
different than in a firm analysis.







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of the factors prevailing, (as in the case of small farms, older farmers, etc.).

the cost to the economy for this particular allocation of resources can be

determined.

Additional information which can be determined directly from a regional

model includes costs of various government programs either in terms of additional

total cost to the economy or in terms of net income foregone to the agricultural

sector, depending upon the particular regional model used.

A. Data requirements

Depending on the complexity of the regional model involved, the

data requirements can be quite similar to the data requirements for firm

analysis problems. For more simple models, where consumption and transporta-

tion problems are not included, the data required are the same production

data used in firm analysis problems. As the regional analysis is made more

complete, transportation and consumption data requirements are encountered.

1. Production Coefficients

Production coefficients required for regional analysis would

be the same as those for firm analysis and the necessity for

consistency in data at least as great. An important and usually

necessary classification is based on soil type. Only soils which

are different enough to have significantly different coefficients

should be considered. Within soil types, differences in regions

due to climate or habits of farmers should be considered, again,

only if these differences are significant.

Judgements concerning farm size are necessary since equipment

costs are affected by the size of farms considered for study.

Area classification within states would be the responsibility

of the individuals in the respective states. Areas should be kept

as few in number and as large as possible but should be sub-divided

sufficiently to show actual differences in production and cost coeffi-

cients.






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2. Consumption Data

The degree of refinement of consumption data in production studies

is usually quite limited due to the area of emphasis of the researchers.

For initial study purposes a few selected consumption areas could be

decided upon. Part of these areas would lie outside the region and part

would be within the region. Quantities of commodities demanded in each

of these consumption centers could either be fixed or could vary according

to the price of the commodity depending upon the type of regional model

used.

3. Transportation data

Estimates of transportation cost between all possible pairs of

production and demand centers would be required. A production center would

be the center for a group of producing areas. For preliminary models, the

accuracy needed in transportation costs would be governed by the degree

of accuracy reflected in the choice of consumption and production centers.

B. Response of individual firms

In the regional analysis the response of whole areas is of major concern

and the response which individual firms might make is given secondary consider-

ation.

One method of determining individual firm response from a regional model

would be to use the same procedure as would be used in the individual firm

analysis described in section I. The advantage of having the regional analysis

available first is that more knowledge is available concerning the types and

magnitudes of adjustments which are reasonable in light of what is known about

interregional competition. Furthermore, a regional equilibrium solution would

yield the prices which would be appropriate to use in the firm analysis.

A second method of determining firm response is one which is derived directly

from the regional solution. One method which has been used is to divide the land

and other capital resources between the full-time operators; the quantity of which
has been determined in the regional solution.