Presentation on theme: "Partial Budgeting Dr. Paul D. Mitchell"— Presentation transcript:
1Partial Budgeting Dr. Paul D. Mitchell Agricultural and Applied EconomicsUniversity of Wisconsin, Madison WI
2Goal of This Presentation Explain purpose of partial budgetsIllustrate their structure and useGive some examples
3Partial Budget Purpose To estimate the net benefit from a small change to a farm operation in order to guide a farm decisionFine tune your current operation: Hold all else fixed and evaluate effect of a small changePartial Budget: focuses only on the things that changeDo not budget each enterprise completely, but build on enterprise budgetsOther names that are essentially the same: Marginal Analysis or Incremental Analysis
4Simple ExamplesPlant rootworm Bt corn or conventional corn with a soil insecticidePlant a little more corn and a little less soybeansRent an additional 100 acres for cornBuy combine or continue custom hiringSell current tractor and buy a bigger oneSoil test for N or just use credits/guess
5Partial Budget Basic Idea Partial Budget: Answer these 4 questions and then do calculations Net Benefit = Benefits – Costs Benefits: 1) What will be the new or added revenues? 2) What costs will be reduced or eliminated? Costs: 3) What will be the new or added costs? 4) What revenues will be reduced or lost?
6Partial Budget: Define the change analyzed Benefits Costs Additional RevenuesWhat will be the new or added revenues?Additional CostsWhat will be the new or added costs?Costs ReducedWhat costs will be reduced or eliminated?Revenues ReducedWhat revenues will be reduced or lost?Total BenefitsTotal CostsNet Benefit
7Planter ExampleLook at buying a planter for 1000 acres of corn and soybean versus using custom hiring of the plantingWhat will be the new or added revenues?Increased yields due to more timely plantingWhat costs will be reduced or eliminated?No longer pay for custom plantingWhat will be the new or added costs?Fixed and variable costs of owning a planterWhat revenues will be reduced or lost?I can’t think of any
8Buy planter vs. custom hire for planting 1000 acres corn-soybeans (500 acres each)Additional RevenuesWhat will be the new or added revenues?Higher yields with more timely plantingAdditional CostsWhat will be the new or added costs?Fixed and variable costs of owning a planterCosts ReducedWhat costs will be reduced or eliminated?No longer pay cost for custom hireRevenues ReducedWhat revenues will be reduced or lost?Can’t think of anyTotal BenefitsTotal CostsNet Benefit
9Buy planter vs. custom hire for planting 1000 acres (500 each) corn-soybeanAdditional Revenues3 bu corn x $4.00/bu x 500 ac= $6,0001 bu soybeans x $10/bu x 500 ac= $5,000Additional Costscorn $19.11/ac x 500 ac= $9,555soybeans $20.38/ac x 500 ac= $10,190Costs ReducedCustom corn planting = $15/ac x 500 ac = $7,500Custom soybean planting = $16/ac x 500 ac = $8,000Revenues ReducednoneTotal Benefits$26,500Total Costs$19,745Net Benefit$6,755
10Planter Example Only focused on costs and revenues that change Purely made up numbers for illustrationEstimate 3 more bu of corn and 1 more bu of soybeans due to more timely plantingCorn = 1% loss/day in WI after May 8Soybeans: 0.25/bu/day in IA studyEstimate cost of owning and operating a planter: Use “Fast and Simple Method” for 100 acres to get corn = $19.11/ac, soybeans = $20.38/acCustom rates: estimates from online WI Custom Rate Guide
11Planter Example: What if “real” Look at your records: How late was your custom planter over the last several years?Estimate the average yield loss you sufferedSeveral equations for corn and soybeans on webCost to own and operate planterUsed the Fast and Simple Method:Is $6,755 ($6.76/ac) enough to justify the added hassle of owning and operating a planter?
12Think BreakSuppose you are a corn-soybean farmer who currently custom hires all combining. You are thinking of buying a combine.Do a partial budget analysis of a Combine Purchase vs. Custom Hire decisionNeeded assumptions/information and questions are given in the next slide
13Think Break: Combine Purchase vs. Custom Hire Corn acres = 2,000; Farm crop acres 4,000Custom Rate = $25/acScale Factor = (33.026/acres)1% yield increase with more timely harvestAverage yield = 150 bu/ac; Price = $4/bu1) What will be the new or added revenues?2) What costs will be reduced or eliminated?3) What will be the new or added costs?4) What revenues will be reduced or lost?5) What’s the net benefit?
14Another ExampleAdd 50 beef cows to your cow-calf herd and convert 100 acres from grain to forage1) What will be the new or added revenues?2) What costs will be reduced or eliminated?3) What will be the new or added costs?4) What revenues will be reduced or lost?5) What’s the net benefit?
15Revenue Benefits 1) What will be the new or added revenues? Sell more steers, heifers, and cull cows46 calves (92% efficiency)Save 5 heifers as replacements (10% cull rate)23 steer calves: 500 lbs x $0.85/lb = $9,77518 heifer calves: 460 lbs x $0.80/lb = $6,6245 cull cows $500 each = $2,500Total = $18,899
16Cost Benefits 2) What costs will be reduced or eliminated? Variable inputs used for grain productionFertilizer, seed, pesticides, etc.: $5,350Labor: $1,500Variable machinery costs: $1,000Interest on variable 6% = $470Total = $8,320
17Cost Costs 3) What will be the new or added costs? Fixed costs Interest on cows and bulls = $2,500Bull depreciation = $300Variable costsLabor = $600, Vet and health = $500Feed/Hay = $2,000, Pasture fertilizer = $1,500Hauling and Miscellaneous = $500Interest on variable 6% = $300Total = $8,200
18Revenue Costs 4) What revenues will be reduced or lost? Grain production from 100 acresCorn: 110 bu/ac x $2.00/bu x 100 ac = $22,000Soybeans: 30 bu/ac x $5.00/bu x 100 ac = $15,000Use half of each, since 2 year rotationTotal = ½ ($22,000 + $15,000) = $18,500
19Partial Budget: Add 50 cows to cow-calf operation and convert 100 acres to forage BenefitsCostsAdditional Revenues23 Steer calves, 18 heifer calves and 5 cull cows = $18,899Additional CostsFixed and variable costs for 50 more cows and needed bulls = $8,200Costs ReducedVariable inputs for grain production = $8,320Revenues ReducedRevenue from corn-soybean production = $18,500Total Benefits$27,219Total Costs$26,700Net Benefit$519
20Comments on AnalysisNote that we needed more complete enterprise budgets for cow-calf and grain operationsFixed cost added for cows and bulls, but no fixed cost change for crop conversion from grain to forage. Why?Labor for cow-calf less than for grain ($600 vs. $1,500), an added benefit – What will you do with the extra time?
21Comments on Partial Budgeting Final comments on Partial BudgetsEconomies of SizeOpportunity CostsSensitivity AnalysisRisk Changes
22Economies of SizeAnalysis assumes proportional (linear) changes in costs and revenue when make small changesLinear (proportional) approximation is fine for small changes, but not for large – need more complete budgeting for large changesAdding 20 cows to herd of 200 will increase labor demand, but likely less than 10%Dropping 100 acres from 1000 acre grain farm will decrease costs, but likely less than 10%
23Opportunity Costs Should be included in the analysis Capital needs change: include costs (benefits) for borrowing more (less) money or locking up more (less) of your capital in farm assetsLabor and Management changes: include the costs/benefits of your and your family's time commitment changesChange farm operation due to changes in credit or labor resources or desires
24Sensitivity AnalysisAssumptions used to construct partial budgets not always known with certaintyYield benefit for more timely plantingCrop yields and pricesMachinery costsRun analysis with a range of assumptionsLow, average, high, or worst and best case scenarioFind break even price or yield and decide how likelyFormally model the uncertainty: use probability distributions, decision trees, or payoff matrices and do risk analysis
25Risk and Partial Budgeting Partial Budgeting ignores changes in riskConverting 100 acres from grain to forage and adding 50 cows to cow-calf operation:What are the risk implications?Without formal risk analysis tools, comparisons usually ignore risk or add afterwards in ad hoc wayHow does the change affect the variability of my income?What the probably that I will at least break even on the change?
26Aggregating Partial Budgets for Impact Analysis Partial budget analysis focuses on a farm to help guide farm decisionsAggregate over farms to estimate the net benefit for many farms making small changes as a result of a programSimple example for a hypothetical IPM program for Wisconsin strawberry growersWI has less than 1,000 acres of strawberriesProgram encouraged switch from a scheduled spray program to scouting-based applications
27Hypothetical Example to Illustrate Based on meetings and small farmer survey of adoptersCategorize impacts as either low and high benefit farmsLow Benefit Farms: switch from 5 sprays to 3 spraysHigh Benefit Farms: switch from 4 sprays to 1 spray, got price premium for “IPM Strawberries” for 10% of cropSpray costs $10/acre for application and a.i.Scouting cost $10/acre for the seasonAverage price = $2.50/lb, $2.65/lb for IPM strawberriesAverage yield = 6,000 lbs/acre
29Partial Budget: Hypothetical Strawberry IPM: High Benefit Farm BenefitsCostsAdditional Revenues10% acres get $0.15/lb higher price, or 10% x $0.15/lb x 6,000 lbs/A = $90/AAdditional CostsScouting costs = $10/ACosts Reduced3 fewer sprays, saving 3 x $10/A = $30/ARevenues ReducedNoneTotal Benefits$120/ATotal Costs$10/ANet Benefit$110/A
30Aggregating Partial Budgets for Impact Analysis Survey shows IPM was adopted on 750 acresLow Benefit Farms: 200 acresBenefit = 200 A x $20/A = $4,000High Benefit Farms: 550 acresBenefit = 550 A x $110/A = $60,500Total Benefit = $64,500
31SummaryExplained and illustrated use of partial budgets using some simple farm management examplesExplained some weaknesses of partial budgets (size economies, opportunity costs, sensitivity analysis, risk)Presented simple IPM example and how to aggregate impacts by multiplying per acre affects by the total acres