PARTIAL BUDGETINGDr. Paul D. Mitchell

Agricultural and Applied Economics

University of Wisconsin, Madison WI

Goal of This Presentation

1. Explain purpose of partial budgets

2. Illustrate their structure and use

3. Give some examples

Partial Budget Purpose

• To estimate the net benefit from a small change to a farm operation in order to guide a farm decision

• Fine tune your current operation: Hold all else fixed and evaluate effect of a small change

• Partial Budget: focuses only on the things that change• Do not budget each enterprise completely, but build on enterprise budgets

• Other names that are essentially the same: Marginal Analysis or Incremental Analysis

Simple Examples

• Plant rootworm Bt corn or conventional corn with a soil insecticide

• Plant a little more corn and a little less soybeans• Rent an additional 100 acres for corn• Buy combine or continue custom hiring• Sell current tractor and buy a bigger one• Soil test for N or just use credits/guess

Partial Budget Basic IdeaPartial Budget: Answer these 4 questions and then do calculationsNet 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?

Partial Budget: Define the change analyzedBenefits 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 Benefits

Total Costs

Net Benefit

Planter Example• Look at buying a planter for 1000 acres of corn and soybean versus using custom hiring of the planting

• What will be the new or added revenues?• Increased yields due to more timely planting

• What costs will be reduced or eliminated?• No longer pay for custom planting

• What will be the new or added costs?• Fixed and variable costs of owning a planter

• What revenues will be reduced or lost?• I can’t think of any

Buy planter vs. custom hire for planting 1000 acres corn-soybeans (500 acres each) Additional Revenues

What will be the new or added revenues? Higher yields with more timely planting

Additional CostsWhat will be the new or added costs?

Fixed and variable costs of owning a planter

Costs ReducedWhat costs will be reduced or eliminated?

No longer pay cost for custom hire

Revenues ReducedWhat revenues will be reduced or lost?

Can’t think of any

Total Benefits

Total Costs

Net Benefit

Buy planter vs. custom hire for planting 1000 acres (500 each) corn-soybean

Additional Revenues3 bu corn x $4.00/bu x 500 ac = $6,0001 bu soybeans x $10/bu x 500 ac = $5,000

Additional Costscorn $19.11/ac x 500 ac = $9,555soybeans $20.38/ac x 500 ac = $10,190

Costs ReducedCustom corn planting = $15/ac x 500 ac = $7,500Custom soybean planting = $16/ac x 500 ac = $8,000

Revenues Reduced

none

Total Benefits

$26,500 Total Costs $19,745

Net Benefit $6,755

Planter Example• Only focused on costs and revenues that change• Purely made up numbers for illustration• Estimate 3 more bu of corn and 1 more bu of soybeans due to more timely planting• Corn = 1% loss/day in WI after May 8• Soybeans: 0.25/bu/day in IA study

• Estimate cost of owning and operating a planter: Use “Fast and Simple Method” for 100 acres to get corn = $19.11/ac, soybeans = $20.38/ac

• Custom rates: estimates from online WI Custom Rate Guide

Planter 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 suffered• Several equations for corn and soybeans on web

• Cost to own and operate planter• Used the Fast and Simple Method:

http://www.aae.wisc.edu/pdmitchell/Fast%20and%20Simple%20Method.pdf

• Is $6,755 ($6.76/ac) enough to justify the added hassle of owning and operating a planter?

Think Break

• Suppose 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 decision

• Needed assumptions/information and questions are given in the next slide

Think Break: Combine Purchase vs. Custom Hire

• Corn acres = 2,000; Farm crop acres 4,000• Custom Rate = $25/ac• Scale Factor = 1.241 + (33.026/acres)• 1% yield increase with more timely harvest• Average yield = 150 bu/ac; Price = $4/bu 1) 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?

Another Example

• Add 50 beef cows to your cow-calf herd and convert 100 acres from grain to forage

1) 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?

Revenue Benefits

1) What will be the new or added revenues?• Sell more steers, heifers, and cull cows

• 46 calves (92% efficiency)• Save 5 heifers as replacements (10% cull rate)• 23 steer calves: 500 lbs x $0.85/lb = $9,775• 18 heifer calves: 460 lbs x $0.80/lb = $6,624• 5 cull cows $500 each = $2,500

• Total = $18,899

Cost Benefits

2) What costs will be reduced or eliminated?• Variable inputs used for grain production

• Fertilizer, seed, pesticides, etc.: $5,350• Labor: $1,500• Variable machinery costs: $1,000• Interest on variable costs @ 6% = $470

• Total = $8,320

Cost Costs3) What will be the new or added costs?• Fixed costs

• Interest on cows and bulls = $2,500• Bull depreciation = $300

• Variable costs• Labor = $600, Vet and health = $500• Feed/Hay = $2,000, Pasture fertilizer = $1,500• Hauling and Miscellaneous = $500• Interest on variable costs @ 6% = $300

• Total = $8,200

Revenue Costs

4) What revenues will be reduced or lost?• Grain production from 100 acres

• Corn: 110 bu/ac x $2.00/bu x 100 ac = $22,000• Soybeans: 30 bu/ac x $5.00/bu x 100 ac = $15,000

• Use half of each, since 2 year rotation• Total = ½ ($22,000 + $15,000) = $18,500

Partial Budget: Add 50 cows to cow-calf operation and convert 100 acres to forageBenefits Costs

Additional Revenues23 Steer calves, 18 heifer calves and 5 cull cows = $18,899

Additional CostsFixed and variable costs for 50 more cows and needed bulls = $8,200

Costs ReducedVariable inputs for grain production = $8,320

Revenues ReducedRevenue from corn-soybean production = $18,500

Total Benefits

$27,219 Total Costs $26,700

Net Benefit $519

Comments on Analysis• Note that we needed more complete enterprise budgets for cow-calf and grain operations

• Fixed 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?

Comments on Partial Budgeting

•Final comments on Partial Budgets• Economies of Size• Opportunity Costs• Sensitivity Analysis• Risk Changes

Economies of Size• Analysis assumes proportional (linear) changes in costs and revenue when make small changes

• Linear (proportional) approximation is fine for small changes, but not for large – need more complete budgeting for large changes

• Adding 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%

Opportunity 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 assets

• Labor and Management changes: include the costs/benefits of your and your family's time commitment changes

• Change farm operation due to changes in credit or labor resources or desires

Sensitivity Analysis• Assumptions used to construct partial budgets not always known with certainty• Yield benefit for more timely planting• Crop yields and prices• Machinery costs

• Run analysis with a range of assumptions• Low, average, high, or worst and best case scenario• Find break even price or yield and decide how likely• Formally model the uncertainty: use probability

distributions, decision trees, or payoff matrices and do risk analysis

Risk and Partial Budgeting• Partial Budgeting ignores changes in risk

• Converting 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 way• How does the change affect the variability of my income?

• What the probably that I will at least break even on the change?

Aggregating Partial Budgets for Impact Analysis• Partial budget analysis focuses on a farm to help guide farm decisions

• Aggregate over farms to estimate the net benefit for many farms making small changes as a result of a program

• Simple example for a hypothetical IPM program for Wisconsin strawberry growers

• WI has less than 1,000 acres of strawberries• Program encouraged switch from a scheduled spray program to scouting-based applications

Hypothetical Example to Illustrate• Based on meetings and small farmer survey of adopters• Categorize impacts as either low and high benefit farms • Low Benefit Farms: switch from 5 sprays to 3 sprays• High Benefit Farms: switch from 4 sprays to 1 spray, got

price premium for “IPM Strawberries” for 10% of crop• Spray costs $10/acre for application and a.i.• Scouting cost $10/acre for the season• Average price = $2.50/lb, $2.65/lb for IPM strawberries • Average yield = 6,000 lbs/acre

Partial Budget: Hypothetical Strawberry IPM: Low Benefit Farm

Benefits Costs

Additional RevenuesNone

Additional CostsScouting costs = $10/A

Costs Reduced2 fewer sprays, saving 2 x $10/A = $20/A

Revenues ReducedNone

Total Benefits

$20/A Total Costs $10/A

Net Benefit $10/A

Partial Budget: Hypothetical Strawberry IPM: High Benefit Farm

Benefits Costs

Additional Revenues10% acres get $0.15/lb higher price, or 10% x $0.15/lb x 6,000 lbs/A = $90/A

Additional CostsScouting costs = $10/A

Costs Reduced3 fewer sprays, saving 3 x $10/A = $30/A

Revenues ReducedNone

Total Benefits

$120/A Total Costs $10/A

Net Benefit $110/A

Aggregating Partial Budgets for Impact Analysis

• Survey shows IPM was adopted on 750 acres• Low Benefit Farms: 200 acres

• Benefit = 200 A x $20/A = $4,000• High Benefit Farms: 550 acres

• Benefit = 550 A x $110/A = $60,500• Total Benefit = $64,500

Summary

• Explained and illustrated use of partial budgets using some simple farm management examples

• Explained 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