Compiled by: Anil Banstola

Agriculture Instructor

Unit 4: Principles involved in farm management decisions

E: Principle of Comparative Advantage

The concept of comparative advantage is associated with

i) Resource productivity

ii) cost of production of enterprise

The principle (law) of comparative advantage directs a farmer in the

selection of crop and livestock enterprise in the production of which available
resources have the greatest relative advantage and not absolutes advantage.
Types of advantages – On the maximum net returns per hectare basis there
are two types of advantages.

1) Absolute advantage. 2) Relative or comparative advantage.

Absolute advantage: Net return per hectare

i.e. Total returns – Cost of production.

Comparative advantage: Refers to relative advantages of growing

different crops in a region. The following table gives idea about these two
advantages.
Table: Net returns of different crops in a region.

Crop Account Crop A Crop B Crop

Total income (Rs.) 3500 7500 10000
Total expenses (cost) 2000 2500 4000
Net returns ( Rs) 1500 5000 6000
Returns per rupee 1.75 3.00 2.5.00
%returns 175% 300% 250%
 Compiled by: Anil Banstola
Agriculture Instructor

From the above figures it can be said that farmers of that region can make
profit by growing any of the three crops as they can get absolute advantages
to the tune of Rs.1500, 5000 and 6000 from Crop A, B and C. But for
making the greatest profit they will have to allocate the largest possible area
under Crop B alone as it has given the maximum relative returns. Thus, if a
cultivator wants to earn greatest possible returns, he should produce those
crops in which their relative advantage is greatest.

The specialized or diversified farming depends largely on this principle e.g.

fruits & vegetables are grown largely in the vicinity of the big Cities.

F: Principle of Time Comparison

Farmers always produce the crops based upon investment and

returns in long run.
Investing in vegetables give instant return within 3 months while
investing in fruits give returns in many years.
a) Compounding

• In long term projects it is possible that costs would increase annually by some per
cent or instead of investing in some activity, the farmer could deposit the money
in the bank. In both cases the farmer would be interested to know the cost or return
in the future. Compounding refers to process of accumulation of money over a
period of time, i.e., future expected value of the present income. It is estimated
using the formula;
S = s (1 + i) n
• ‘S’ represents the sum at the end of ‘n’ periods; ‘s’ the amount which is invested for
‘n’ periods; ‘i' the interest rate.

b) Discounting

• Discounting income is the procedure whereby the present value of the future
income is determined.
q
Formula: PV =--------------
(1 + r)n
Where,
PV = present value of the future amount,
q = future amount
r = rate of interest
n = no. of years in the future