An understanding of the meaning and implications of "cost of production" is essential to anyone who would form an intelligent opinion on several present day proposals for agricultural reform.
Interest in farm cost has been expressed by various groups in the United States for about 40 years. The source of demand for "cost of production" prices depends on the direction of current price movements. When prices were rising consumers have demanded that prices of foods and other necessities of life be kept down to the costs of producing them. When prices were falling groups of farmers often demanded that prices be kept up to the level of costs.
Studies of farm costs were undertaken after the war in a large number of states, including Iowa, when it was thought the government might continue to fix prices in some arbitrary manner. Results of these studies were disappointing to the people who made them. When prices rose in 1922 and following years, farmers lost interest since "cost of production" prices would have caused them losses under these circumstances.
There are three principal methods of obtaining data needed in efforts to determine production costs. These are by estimation, by surveys and by actual records kept on farms. Only the latter has any serious claim to validity. Even this method has certain drawbacks; since the men who are interested in keeping the necessary records are likely to be better than average farmers.
The basic elements of cost are wages on labor, interest on capital used, rent on land and the earnings of management. In placing valuations on these factors, on the ordinary farm, it has not been possible to solve some difficulties. Much of the labor is usually done by the farmer himself or by members of his family. Part or all of the capital may be owned by him. Much of it may represent previous investments which would not be repeated in their present form and which cannot be liquidated. No certain valuations can be placed on these factors of production contributed by the farmer. Rent on land is determined by prices of farm produce, not the value of produce by the rate of rent. Therefore, rent cannot be used as an element in the determination of necessary price. The fourth element, returns on management, varies from farmer to farmer with ability in planning and operating the business.
Even if valuations on the factors of production were agreed upon, there would still be serious difficulties in the way of apportioning them to individual products- unless the farm produced a single marketable crop. The farm is operated and should he treated as a unit. Many expenses apply in indivisible proportions to two or more products, as wool and mutton in the production of sheep, or grain and straw, or cotton and cottonseed.
So-called cost figures obtained under these conditions are without significance as far as necessary price is concerned. The results depend too much on arbitrary methods and change with the method used.
"Cost of production" figures are discredited as a basis for price fixing and for tariff determination. They have been used in various public hearings but figures which arc more easily understandable and not open to challenge would ordinarily be preferable as well as more pertinent.
When constructed with some care, figures of this same nature are, however, usable as indicators of efficiency in particular enterprises as between farms. Such use should be limited to groups of farms operating under essentially similar conditions and in the same year. In fact, they are seldom used in this manner because of the expense involved in their collection.
The "cost of production" indexes are found to have certain well defined statistical characteristics. They tend to vary in a proportional rather than an' absolute manner between farms; suggesting that the further efficiency in production is increased, the more difficult it becomes to increase it further. Also a farm with high cost indexes in one year tends to be found in this same relative position the next year.
The common assumption that "price must equal cost" should be examined carefully before an effort is made to base any practical program on it. In strict logic, such a relationship would be necessary only in case of a long continued static economic condition. Price would tend to equal cost if methods of production, price levels, volume of demand and of production remained unchanged for a protracted period. Over a short period of time in a dynamic world, there is no necessary relationship between cost and price.
Different costs have different significance. Producers will continue to operate their farms or factories without getting back all of their investments in long lived improvements, provided the price is sufficient to cover operating expenses plus something on fixed charges. The wide-awake business man operates his plant with more of an eye to future opportunities than to past investments.
The alert farmer will find his interest served better by careful budgeting or planning for the future than by any reckoning of his past costs. This method of budgeting or planning is practically usable and represents the process of thought which is followed by business-like farmers. It has the advantage of being applicable to the farm as a whole and shows each enterprise in its proper relationship to the rest of the business.
Hopkins, John A. and Taylor, Paul A.
"Cost of production in Agriculture,"
Research Bulletin (Iowa Agriculture and Home Economics Experiment Station): Vol. 15
, Article 1.
Available at: https://lib.dr.iastate.edu/researchbulletin/vol15/iss184/1