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  • The agricultural sector is a key player in the economy of our country.
  • It is a major employer and brings a lot of national income through foreign exchange.

National Income

  • These are the total earnings from goods and services produced by a country in a period of one year.

Relationship Between Firm and Household

  • A household is considered to be a unit comprising a farmer and family members.
  • It produces raw materials and consumes manufactured goods.
  • A firm on the other hand, is any manufacturing or processing unit which consumes raw materials and produces manufactured goods.
  • Both household and firm generate income, which in turn, is used to:
    • Improve the standard of living of the household members by paying for essential goods and services.
    • The firms build more industries to create more employment and revenue through salaries and wages.
    • Finance government projects through taxes and hence further national development.


Gross Domestic Product (G.D.P.)


Gross National Product (G.N.P.)

  • Is the sum total of G.D.P. and the difference between income inflow (revenue coming into the country from outside) and income outflow (money going out of the country by foreign investors).
    It represents the total income earned within the country and from abroad.


Per Capita Income

  • Is the Gross National Income (in terms of revenue) divided by the number of people living in the country.
  • It is not a good measure of the economic wellbeing of the people
    because of the

    uneven distribution of income among them.


Contribution of Agriculture to National Development
  • The interaction between household and the firm generate income which is used to finance further expansion of the firms.
  • This creates more employment and revenue.
  • The  government  taxes  the  income  to  finance  national  development programmes such as;
    • health,
    • education,

    • water, energy

    • communication.


Factors of Production

  • A factor of production is anything that contributes directly to output, that is, it is a productive resource.
  • Productive resources usually employed in the production of goods and services. Incl ude:
    • Land

    • Labour
    • Capital
    • Management


  • As a factor of production, refers to the natural characteristics and properties of a given area of land.
  • The key factor here is productivity for example soil fertility, presence of water and minerals and is always fixed and has no geographical mobility.



  • Besides being a consumer, human beings are also a factor of production.
  • They provide the labour force (human power) required in the production process.
  • Labour is assessed in terms of productivity and not mere numbers of workers or labourers.
  • Labour is measured in terms of man hours, man days or man months. The labourer’s productive capacity depends on such factors as;

    • age,
    • health,
    • state of nutrition
      level of education.
  • The amount of work and the efficiency with which it is performed determines the quality of labour.


  • Capital refers to all man-made assets that help land and labour to produce.
  • It is categorized into:
    • Working capital
      Liquid capital





Capital for example

  • machinery,
  • buildings
  • permanent improvements on land like fences,
  • roads,
  • irrigation facilities

    water supply system.


Working capital

Which include consumer goods such as;

  • fertilizers,
  • livestock feeds,
    fuel in store,


Liquid capital;

For example;

  • ready money,
  • bank deposits,
    shares in financial institutions.


  • It is a process of decision making in the farm.
  • Managers use their knowledge and judgment to decide how to combine the other three productive resources in the best way possible.
  • They make plans, execute them and bear the risks or consequences which such plans entail.

Production Function


  • Production function is a physical relationship between inputs and outputs in a production process.
  • It tells the quantity of output (product) that may be expected from a given combination of inputs.
  • Production function may be expressed in table form or graphically as a curve.





Feeding pigs for pork production at varying levels of concentrate feed.


Unit of feed

Body wt.




Gains (kg)


products (kg)






Image From


Types of Production Functions

  • A production function assumes three forms which may be treated as different types:
    • Increasing Returns
    • Constant Returns
    • Decreasing (Diminishing) Returns


Increasing Returns

  • In this type, each additional unit of input results in a larger increase in output than the preceding unit.
    This shows that resources are under utilized.

Constant Returns

  • The amount of the product increases by the same amount for each additional input that is constant returns to input factor.
    Again here resources are under utilized.

Decreasing (Diminishing) Returns

  • Here, each additional unit of input results in a smaller increase in output than the preceding unit.
  • Resource use is stretched to the maximum.
  • It is the most commonly encountered form in agricultural enterprises;
    It gives rise to the law of Diminishing Returns.


  • Feeding dairy cows for milk production with varying amounts of feed.

  • Crop responses to application of varying amounts of fertilizers.
  • Use of varying units of labour on fixed unit of land.


Economic Laws and Principles

The Law of Diminishing Returns


  • The law of diminishing returns states that;

if successive units of one input are added to fixed quantities of other inputs a point is eventually reached where additional product (output) per additional unit of input declines.”

  • This law is encountered practically in all forms of agricultural production.
  • It is useful in determining the most rational and profitable level of production.



Production of maize at varying levels of N.P.K. fertilizer application on a fixed area of land.


Unit ofNPK







































Zones of a production function curves



Image From

Zones of a production function curves these are:

 Irrational zone or Zone I.  Rational zone or Zone II  Irrational zone or Zone III.


  • The three zones are arrived at by drawing two perpendicular lines through the production function curve, one at MP = AP and another at MP=O.
  • In Zone I resources are not fully utilized while in Zone III, excessive application of resources leads to production decline or loss.
  • It is not economical to produce at these levels.
  • In Zone II resources are maximally utilized resulting in maximum production.
  • It is therefore economical (or wise) to produce at this level.


Principle of Substitution

States-”if the output in a production process is constant, it is profitable to substitute one input factor for another, as long as it is cheaper than its next alternative.”


  • This principle is applicable in a situation where more than one variable input factors are used.
  • For example feeding hay and concentrates for milk production, farmyard manure and phosphatic fertilizers in the production of maize.
  • The basic problem that the producer wishes to solve when two input factors are used in combination is in what proportions must the variable inputs be combined in order to produce at a minimum cost and hence attain maximum profit.

  • To solve the above problem, the producer must determine the least cost combination of inputs used.
  • The least cost combination is attained at a point where the Marginal Rate of Substitution (MRS) equals the inverse of price ratio of the factors involved.


That is:

Image From x2
= P X1


Image From X1= P X2


X1 – first input factor

X2– second input factor


change (increase or decrease)

P – price (cost of input fators)


Examples: Image From

  • Producing 20 bags of maize using varying combinations of farmyard manure and phosphate fertilizers.
  • Price of farm yard manure (FYM) is KShs10/- per unit and that of phosphate fertilizer is Kshs 50/– per unit













X1 (P-fert)



Image From X1


100kg units

100kg units
































In the above example, the following assumptions are made:

  • A fixed quantity of output is to be produced.
  • Input factors in combination substitute for one another at varying rates.
  • Relative prices of input factors do not change drastically during the period of production.

NOTE: one input factor substitutes for the other at diminishing varying marginal rate of substitution.


Principle of Equimarginal Returns

  • This principle states ” That the last unit of an input factor spent in one enterprise yields a marginal return exactly equal to the marginal return earned from the last unit invested in each of the other enterprises.”



  • If the last shs.100/spent buying cattle feed will return more than shs. 100/= spent on buying fertilizer for growing maize, then it is advisable to purchase more feed up to a point where the last shs.lOO/- spent on it will return exactly the same as the last shs.100/spent on fertilizers.
  • This concept is only relevant in a situation where farmers do not have adequate capital to employ inputs up to the level where marginal revenue equals the marginal cost.


The principal of Profit Maximization

  • The profit is defined as the difference, in monetary terms, between the total returns (income) and total costs (expenses) in a production process.
  • Profit maximisation aims at obtaining the highest returns at a minimum cost per unit of input factor used.
  • This can be done by considering two concepts.

Marginal Concept

  • Profit is maximised when the marginal (additional or extra) revenue (MR) is equal to, or slightly higher than, the marginal cost (Mc).
  • At this point every added input factor brings in higher returns than the expenses incurred in investing it.


Net Revenue Concepts

  • Profit is said to be maximized in a production process when the Net Revenue (differences between total revenue and total costs) is the highest that is
    NR = TR TC.

  • This is arrived at by analyzing the total cost and total revenue earned from a particular enterprise and then subtracting the former from the latter.


When calculating the profit using whatever concept, the following assumptions are made:

  • Cost of inputs (such as fertilizers, labour) remains constant during the period of production.
  • Price of the produce (product) remains unchanged.
    Fixed costs are ignored that is only varying costs directly involved are considered.


Farm Planning

  • Planning is the process of establishing the organizational objectives and defining the means of achieving them.

Factors to consider in drawing a farm plan.

  • Size of the farm.
  • Environmental factors.
  • The current trends in labour markets.

  • Farmer’s objectives and preferences.

  • Possible production enterprises.
  • Existing market conditions and price trends.

  • Availability and cost of farm inputs.

  • Government regulations/policy.
  • Security.
  • Communication and transport facilities

Farm Budgeting

  • Farm budgeting is the process of estimating the future outcomes of a proposed farm plan,
  • That is; the future incomes and expenses of a farm plan.

Importance of Farm Budgeting

  • It helps the farm in decision making.

  • It helps the farmer to predict future
    returns that is planning ahead.
  • It helps the farmer to avoid incurring losses by investing in less profitable enterprises.
  • It helps the farmer to secure loans from financial institutions such as Agricultural Finance Corporation and commercial banks.
  • It ensures a periodic analysis of the farm business.
  • It acts as a record which can be used for future reference.
    It pinpoints strengths or weaknesses in farm operations.


Types of Budgets


Partial Budget

  • It represents financial effects on minor changes in a farm organisation.
  • It is necessary when a farmer wants to replace or reduce enterprise.


Complete Budget

  • A complete budget is necessary when the farmer wants to start a new business where both the variable costs and the fixed costs are likely to be affected.
    It involves a major change or reorganization in the farm business.


Agricultural Services Available to the Farmer:

  • Agricultural production efficiency is greatly increased by services rendered to the farming communities by;
    • Government institutions
    • Non-governmental organizations.

Some of these services are:

  • Extension and Training:
  • Banking Services:
  • Credit:



Extension and Training:
In the field and in farmers training centres.


Banking Services:

  • These enables the farmers to save some of their farm income and invest them in future projects. Credit:
  • Credit is a financial assistance advanced to agricultural farmers to finance their farm projects and repay it with interest.
    It is a borrowed resource.


Types of Credit

  • Credit is categorised according to;
    • Time of repayment
    • The types of projects to be financed.

Examples are:

Short-term Credit

  • Repayable within one year and is advanced for the purchase of;
    • seeds,
    • fertilizers,
    • animal feeds .


Medium-term Credit

  • Repayable within 2 – 5 years and is used to finance projects such as;

    fencing materials,
    purchase of livestock,
    light farm equipment .


Long-term Credit

  • Repayable period is up to 15 years and even more.
  • It is given for the long-term or durable projects such as;
    • purchase of land,
    • construction of soil and water conservation structures,
    • farm buildings,
    • irrigation projects for perennial cash crops for example;

      farm machinery


Sources of Credit

  • Co-operative societies and unions.
  • Crop boards.
  • Commercial banks.
  • Agricultural Finance Corporation.
  • Insurance companies.
  • Individual money lenders.
  • Settlement fund trustee.


Artificial Insemination Services:

  • Provides farmers with semen from improved or superior bulls to improve their livestock herds through controlled breeding.


Agricultural Research Organization

  • These develop and pass on to farmers, improved production techniques as well as crop and livestock species with better performance in different ecological zones.

Marketing Outlets

  • These are agencies that ensure effective and efficient conveyance of farm produce to points of processing and consumption.
  • They are largely crop marketing boards or corporations and cooperative societies.

Veterinary Services

  • In the field are veterinary officers who help the farmer in treating and controlling livestock diseases and parasites.

Farm Input Supplies

  • Farmers are able to obtain their farm inputs from organizations such as co-operatives and private companies.
  • These organizations bring inputs closer to the farmers for example Kenya Farmers Association and private agrovets.


Tractor Hire Services

  • This involves hiring of tractors and machinery at a cost by farmers who are not privileged to own their own.



  • Ministry of Agriculture
    Private contractors.
  • Individual farmers.
    Other service providers.

Risks and Uncertainties in Farming

  • Uncertaintyis the state of not knowing about future events or outcomes.
  • Risks-is the difference (divergence) between the expected and the actual outcome.


Types of Risks and Uncertainties

  • Fluctuation of commodity prices.
  • Physical yield uncertainty.
  • Ownership uncertainty.
  • Outbreak of pests and diseases.
  • Sickness and injury.
  • New production technique.
  • Obsolescence for example machinery may become outdated or obsolete within a short time.
  • Death of either farmer or livestock.
  • Natural catastrophies such as;

    • floods,
    • drought,
    • earthquakes,
    • storm and strong winds which may destroy crops or kill the animals.
      Ways in Which Farmers Adjust to Risks and Uncertainties
  • Diversification.
  • Selecting more certain enterprises.
  • Contracting.
  • Insurance.
  • Input rationing.
  • Flexibility in production methods.
  • Adopting modern methods of production.


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EcoleBooks | Agriculture Form 4 - Agricultural Economics III: (Production Economics)


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