AECO 110

AGRICULTURAL PRODUCTION ECONOMICS

Lecture 3
Derived Demand and the Supply Function

Nora DM. Carambas

 Lecture 3.1
DERIVED DEMAND FOR INPUTS

N. DM. Carambas, DAAE-UPLB, 2017

Derived Demand for Input

− derived from the underlying demand for the

commodity being produced.
− defined for the strictly concave region (Stage II)
of the production function where the SOCs are
satisfied.

N. DM. Carambas, DAAE-UPLB, 2017

Factors Affecting Input Demand

1. Price of the output being produced (+)

2. Own price of the input (-)
3. Price of other substitute or complementary
inputs that are also in the production function
(+, -)
4. Technical coefficients or parameters of the
production function itself (+)
e.g. partial production elasticities and shifer
5. Other factors, e.g. availability of funds for the
purchase of inputs (+)

N. DM. Carambas, DAAE-UPLB, 2017

Input Demand Function Derivation:
One-Input Case
The demand function for input is mathematically
expressed as:
𝒙 = 𝒇 𝒂, 𝒃, 𝒗, 𝒑
Mathematical derivation makes use of the FOC
for unconstrained profit maximization, i.e.

𝑴𝑽𝑷 = 𝑴𝑭𝑪 or
𝑷 ∗ 𝑴𝑷𝑷 = 𝑽

Input Demand Function when re-arranged!!

N. DM. Carambas, DAAE-UPLB, 2017

Input Demand Function Derivation:
One-Input Case
Consider PF
𝒚 = 𝑨𝒙𝒃 and let 𝑷𝒚 = 𝒑 and 𝑷𝒙 = 𝒗.

Max 𝝅 = 𝒑𝑨𝒙𝒃 − 𝒗𝒙
The FOC is:
𝒑𝒃𝑨𝒙𝒃−𝟏 − 𝒗 = 𝟎 𝒐𝒓
𝒑𝒃𝑨𝒙𝒃−𝟏 = 𝒗
N. DM. Carambas, DAAE-UPLB, 2017
Input Demand Function Derivation
A. One-Input Case

Rearranging the FOC gives the demand function:

𝟏
𝒑𝒃𝑨 𝟏−𝒃
𝒙=
𝒗

+ + + -
𝒙 = 𝒇(𝑨, 𝒃, 𝒑, 𝒗)

N. DM. Carambas, DAAE-UPLB, 2017

Input Demand Function Derivation
A. One-Input Case

Input demand curve

The input demand function normally

begins at the start of stage II and
ends at the start of stage III.

N. DM. Carambas, DAAE-UPLB, 2017

Input Demand Function Derivation:
Two-Input Case
The demand function for input i is mathematically
expressed as:

xi = f(bi, bj, vi, vj, p)

Mathematical derivation also makes use of the

FOCs for unconstrained profit maximization.

Consider: y = Ax1b1x2b2, Py = p, Px1 = v1, PX2 = v2

 = pAx1b1x2b2 – v1x1 – v2x2

N. DM. Carambas, DAAE-UPLB, 2017

Input Demand Function Derivation:
Two-Input Case
FOCs:
Pb1Ax1b1-1x2b2 – v1 = 0
Pb2Ax1b1x2b2-1 – v2 = 0

Demand Functions:
x1 = v1(1-b2)/v2b2/ (pA)-1/b1b2-1/b2-b2/
 x1 = f(v1, v2, p, b1, b2, A)

x2 = v1b1/v21-b1/ (pA)-1/b1-b1/b2b1-1/
 x2 = f(v1, v2, p, b1, b2, A)

where:  = b1 + b2 – 1
N. DM. Carambas, DAAE-UPLB, 2017
 Input Demand Function Derivation:
Two-Input Case
Example: y = 2x10.2x20.3

x1 = 0.204p2v1-1.4v2-0.6

x2 = 0.306p2v1-0.4v2-1.6

Input demand functions are homogeneous of degree

zero with respect to input and output prices.

 a proportionate increase in input and output prices

all at the same time will not affect the quantity of
the input demanded.

For instance, if the price of output would be doubled

and the price of all variable inputs would also be
doubled, the net effect of these changes in prices
will be zero. N. DM. Carambas, DAAE-UPLB, 2017
The Elasticity of Input Demand

1. OUTPUT-PRICE ELASTICITY OF INPUT DEMAND

(x,p)

 measures the responsiveness of the quantity

demanded of an input to changes in the price of
the commodity produced.

%x x p  ln x
 x, p   
%p p x  ln p

N. DM. Carambas, DAAE-UPLB, 2017

The Elasticity of Input Demand
2. Own-Price Elasticity of Input Demand
(xi,vi)

 measures the responsiveness of the quantity

demanded of an input to changes in the price of
that input.
%xi xi vi  ln xi
 x ,v   
i i
%vi vi xi  ln vi

N. DM. Carambas, DAAE-UPLB, 2017

The Elasticity of Input Demand
3. Cross-Price Elasticity of Input Demand (xi,pj)

 measures the responsiveness of the quantity

demanded of an input to changes in the price of
the other input.

%xi xi v j  ln xi
 x ,v   
i j
%v j v j xi  ln v j

N. DM. Carambas, DAAE-UPLB, 2017

Technical Relationship of Inputs
1. Technical Complements
An input is a technical complement for another
input if an increase in the use of this input
causes the marginal physical product of the
other to increase.
∂(MPP1)/∂x2 > 0

e.g., potash and phosphate in corn production

forage and concentrate in dairy production
labor and machine

Inputs are technical complements for a broad class

of Cobb-Douglas type of production functions.

e.g. y = Ax1b1x2b2 Prove.

N. DM. Carambas, DAAE-UPLB, 2017
Technical Relationship of Inputs
2. Technical Competitiveness
An input is said to be technically competitive
with, or substitute of, another input if when
the use of this input is increased, the marginal
physical product of the other input decreases.

∂(MPP1)/∂x2 < 0

Inputs that serve the same function/purpose in the

production process are technical substitutes.
e.g., ammonium nitrate and anhydrous ammonia.

They occur in additive production function with

negative interaction term.
e.g. y = ax1 – bx1x2 + cx2 N.Prove.
DM. Carambas, DAAE-UPLB, 2017
Technical Relationship of Inputs
3. Technical Independence
An input is said to be technically independent of
another input if when the use of this input is
increased, the marginal physical product of the
other input does not change.

∂(MPP1)/∂x2 = 0

Inputs in the additive production functions without

interaction terms are technically independent.

e.g. y = ax1 + bx2 Prove.

N. DM. Carambas, DAAE-UPLB, 2017

 Lecture 3.1
Extension

DECOMPOSITION OF THE TOTAL

EFFECT OF A CHANGE IN THE
PRICE OF AN INPUT

N. DM. Carambas, DAAE-UPLB, 2017

One-Input Case

It is expected that dx/dvx < 0 due to the

presumption that MPPx declines as the
quantity of x employed increases.

 A fall in vx means that more x must be used

to bring about the equality P.MPPx = vx.

N. DM. Carambas, DAAE-UPLB, 2017

Two-Input Case

The assumption of diminishing MPP to determine

the effect of a change in the price of an input
can be misleading.

If v1 falls there will not only be a change in x1 but

also a change in x2 as new cost-minimizing
combination of inputs is chosen.

When X2 changes, the entire MPP1 function

changes because x1 now has a different
amount of x2 to work with.

N. DM. Carambas, DAAE-UPLB, 2017

Two-Input Case
The total effect of a change in the price of an input
can be decomposed into two components:
Substitution Effect (SE)
− the change in input usage attributable
exclusively to change in the relative input price,
output held constant.
− always negative, i.e., 𝝏𝒙𝟏 𝝏𝒗𝟏 ⎹ 𝒚<𝟎

Output Effect (OE)

− the change in input usage attributable
exclusively to a change in output level, input
price remaining constant.
− negative if the input is normal and positive if
𝒗𝟏
the input is inferior. i.e., 𝝏𝒙𝟏 N.𝝏𝒗DM.
⎹ <, > 𝟎
𝒗𝟐
𝟏 Carambas, DAAE-UPLB, 2017
Two-Input Case

Normal Input – an input whose rate of usage

increases as the quantity of output being
produced increases.

Inferior Input – an input whose rate of usage

decreases as the quantity of an output being
produced increases.

N. DM. Carambas, DAAE-UPLB, 2017

Graphical Decomposition
Assume two inputs x1 and x2, and price of x1
decreases.

x2

C
x2’
TE ÓE A
x20
SE
B
x2” 𝒚’
SE OE
TE 𝒚
0
x10 x1’ C C” Co’ x1
x1”

N. DM. Carambas, DAAE-UPLB, 2017

Explanation
A. Own-Price Effect (x1/v1)
x1/v1 must be negative!!
Substitution Effect
If y is held constant at 𝒚, there will be a tendency
to substitute x1 for x2 in the production
process as x1 becomes relatively cheaper.
 The use of x1 will increase and the use of x2
will decrease.

Recall: Condition for minimizing the cost of

producing a given level of output,
MRTSx1,x2 = v1/v2
 a fall in v1 will necessitate a movement from
input combination A to combination B. 2017
N. DM. Carambas, DAAE-UPLB,
Explanation
Output Effect
If v1 would fall, output of the product could be
increased because of either or both of the
following:
1. the same cost outlay will allow the farm with
limited funds to hire more factors.
2. the lower cost ratio allows output to be
extended further before MFC exceeds MVP for
farm with unlimited capital.

N. DM. Carambas, DAAE-UPLB, 2017

Explanation
B. Cross-Price Effect (∂x2/∂v1)
The sign of ∂x2/∂v1 is indeterminate for normal
input.
Substitution Effect
A fall in v1 will cause a substitution away from x2.
 Less x2 will be used to produce a given
level of output (∂x2/∂v1 > 0).
Output Effect
But the output effect will cause more x2 to be
used as part of the farm’s increased
production plan if the input is normal.
 ∂x2/∂v1 < 0
Q: What would be the output effect when input is
inferior? N. DM. Carambas, DAAE-UPLB, 2017
Example
Consider a farm with unlimited funds & whose PF is
given by:
y = 0.6N0.4L0.3
where
Y – quantity of crop output (ton)
N – quantity of land (ha)
L – quantity of labor (man-day)
Let the initial prices of inputs and output be given as
follows:
r = land rent = P1,000/ha/season
w1 = wage rate = P200/day
p = price of output = P7,000/ton
FC = P4,000 N. DM. Carambas, DAAE-UPLB, 2017
Example
Suppose wage decreases, such that w2 =
P150/man-day, how much will be the total
effect on the labor and land usage? How much
of the total effect is due to substitution effect
and how much is due to output effect?

What will be the total effect on land and labor

usage when funds are limited at the initial
expenditure level? Decompose these total
effects to component substitution and output
effects.

N. DM. Carambas, DAAE-UPLB, 2017

N. DM. Carambas, DAAE-UPLB, 2017
N. DM. Carambas, DAAE-UPLB, 2017
End

N. DM. Carambas, DAAE-UPLB, 2017