Factors of Income

Orlin J. Scoville.

Farmers try to select soil-management practices and systems that will give them the highest sustained net income. Usually they are interested in maximum income over a period of years.

Circumstances sometimes may cause them to discount future incomes rather heavily in favor of high immediate income. Conversely, farmers are willing under some conditions to forego maximum short-run income to enhance annual returns at some future time.

An important economic principle that affects soil management is the diminishing returns relationship, which applies to the amount of product obtained from successive increments of a variable resource applied to a fixed amount of some other resource.

As more of a resource is applied to a given amount of a fixed resource, a point is reached beyond which the additional product obtained per unit of the added resource declines. Each additional unit applied gives a little less additional product than the preceding unit. With very heavy application, additional amounts of the resource may give no increased production, or they may actually reduce the amount of product obtained.

The fertilizer response curve illustrates the working of this principle. The management problem that arises from this relationship is concerned with the determination of the amount of fertilizer to be applied per acre for a given crop to give maximum profit. If there is no uncertainty as to the yield to be obtained, and if unlimited capital and an abundant supply of fertilizer are available, the optimum rate will be that amount at which the last pound of fertilizer applied produces just enough product to be worth the additional cost. If there is uncertainty as to the expected yield, or if capital or the supply of fertilizer is limited, the optimum rate of application will be somewhat less. These special problems, however, I discuss later.

The diminishing return relationship applies also to yield responses from such management practices as the rate of applying irrigation water, number of cultivations, and rate of seeding.

The principle of diminishing returns is presented most simply in terms of varying the amount of one resource applied to one or a group of fixed resources. It can also be thought of in terms of a group of variable resources applied to one or a group of fixed resources. If the amounts of all the resources used in producing a crop were increased without varying the proportions among them, production would increase at a constant rate. Farmers always have some resources that are fixed in amount, however. Usually the supplies of land and management and often the supply of capital are limited.

An important economic problem with which farmers must deal in making their production plans has to do with the choice of crops to be grown. A farmer must determine how much of each resource available to him should be used in producing each possible alternative crop and livestock enterprise adapted to his locality. As far as soil management is concerned, the economic relationship that is basic to solution of this problem is that of substitution among products, or the rotation relationship.

If the use of resources in production of each crop were independent of the use of resources in the production of other crops, a farmer might simply figure for each crop the amount of resources needed in growing 1 acre, subtract the cost of these resources from the expected value of the crop, and produce only the crop that gives the highest net returns an acre, at least to the extent possible without damaging the soil. But production of one crop may influence the production of another, and knowledge of the rotation relationship is important.

An analysis of rotation experiments shows that sometimes the maximum quantity of grain is not produced by an all-grain farming system. The introduction of a legume or other forage crop may increase acre yields of grain enough to result in a higher total production of grain. As the proportion of acreage devoted to forage is increased further, a point is reached at which total production of grain declines.

Aside from any differences in the costs of production, the most profitable rotation depends on the relative prices of grains and forages and the effects on production that result when grains and forages are substituted for each other in the rotation.

As long as a forage crop can be substituted for a grain crop in the rotation with an increase in total production of grain, the rotation relationship between grain and forage crops is said to be complementary. Substitution of forage for grain is almost certain to be profitable within this range. Beyond this range, as the further substitution of forage reduces total production of grains, it is necessary to compare the reduction in total production of grain and the associated increase in production of forage with the ratio between prices of grain and prices of forage. The most profitable rotation will be the one at which the ratio of substitution in production is inversely proportional to the ratio between prices. In other words fbg/itf=ptf/pbg. In the equation, fbg means fewer bushels of grain; itf means increased tons of forage; ptf means the price of a ton of forage; and pbg means the price of a bushel of grain.

Besides the competing and complementary relationships among crop enterprises, there is a supplementary relationship. A crop is said to supplement others when it can be added to a rotation without affecting the production of the other crop: It uses resources not used by the other crop or uses them at a time when they are not being used by other crops. Small grain seeded with a grass or legume seeding sometimes may be supplementary. In double-cropping, the two crops grown on the same piece of land in the same year are supplementary.

Livestock enterprises enter into the production plans of most farmers. Selection of the most profitable rotation for a livestock farm should not stop with an analysis based on market values of forage and grain crops. Further consideration should be given to the additional value of these crops when processed through livestock.

The analysis of the rotation relationships I mentioned might be considered a first approximation of the most profitable rotation for such farms. Later analysis of the most profitable crop and livestock system for the whole farm might mean some modification of the rotation. The analysis can be made by farm budgeting that is, by setting up alternative systems and calculating the expected costs and returns to the farm as a whole from each system.

Having chosen the enterprises to be produced, a farmer has a further choice as to method of production. His resources need not necessarily be combined in fixed proportions to produce a crop. He can use more land and less labor and fertilizer per 100 bushels (extensive farming), or he can use less land and more labor and fertilizer (intensive farming). Viewed in this way, labor, fertilizer, and irrigation water can be thought of as substitutes for land in the production of a given quantity of a crop.

THERE IS NO ONE "best combination" of land, labor, and capital for production under all conditions.

A drop in the price of fertilizer in relation to the price of land will make it profitable to substitute more fertilizer for land. An invention that makes it cheaper to pump water will make it profitable to substitute more irrigation water for land. As with the rotation relationship, the rates at which production resources substitute for each other vary.

With an initial application of fertilizer to a particular soil, it may require only 50 pounds to give production equal to the production that could be obtained from an unfertilized acre. The next 50 pounds might replace or substitute for only three-fourths of an acre of land. The third 50 pounds might replace only one-half acre. As with the substitution of one product for another, the rule is that production resources should be substituted for each other until the rate of substitution is inversely proportional to the ratio of their prices.

This relationship assumes a free market for all kinds of resources a condition that often does not prevail. Farmers often cannot increase or reduce at will the acreage of land they farm. Farmers tend to regard land as a fixed resource, at least in the short run. But a farmer can still combine resources in varying proportions in producing a crop. He can add land and nonland resources together in proportions that make their marginal rates of substitution inversely proportional to their prices.

The nature of the substitution relationship of nonland resources (such as fertilizer and irrigation water) for land is obviously of importance in connection with land-retirement programs. The extent to which it pays to substitute other resources for land will largely determine the effectiveness of such programs in controlling total farm production.

If farmers had abundant capital and perfect knowledge concerning the productivity of farm practices and if they were not confronted by uncertainty as to the growing season and future prices, they would adjust their cropping systems and soil-management practices according to these general principles. They would adjust the cropping system by substituting one crop for another until they had maximized returns; they would substitute resources for each other in the production of each crop to maximize net production per dollar of resources used; and they would invest resources in production until the last dollar's worth used just paid for itself.

Farmers' resources, however, are limited. The capital resources a farmer owns plus the amount that he can borrow do not permit him, as a rule, to invest in production up to the margin at which the last dollar he invests just pays for itself.

For farmers with limited resources, the important principle for the application of resources to alternative production purposes is the principle of equimarginal returns. This means that each dollar's worth of resource should be applied to a particular purpose so long as the added return from the resource is equal to or greater than the return that could be realized in any alternative use.

Thus a farmer would apply enough fertilizer to corn so that an additional dollar's worth would result in an expected return of 1.25 dollar only if enough capital would be left to permit other crops also to be fertilized to the point at which an additional unit applied would also bring a return of 1.25 dollar. Similarly, a decision as to the total amount to be spent for fertilizer should be based on an attempt to equalize the expected return from an additional or marginal unit of fertilizer and an additional or marginal outlay for some alternative purpose for instance, for insecticides or purchased feeder livestock.