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Economic Resources and Their Respective Returns

Economics is the study of using resources to produce goods and services as effectively and efficiently as possible to satisfy the needs and wants of consumers. Our economic system is based on the idea that the individual who provides the economic resource is entitled to be compensated.

The following list summarizes a traditional description of economic resources and their respective returns. The second list suggests an alternative description that reflects changing business relationships. A case study provides an example that illustrates an application of the alternative description.

Traditional Description

Land -- Rent
Labor -- Wage
Capital -- Interest
Entrepreneurial Ability -- Profit

Alternative Description

Land -- Rent
Labor (including management) -- Wage
Capital -- Interest
Information -- Royalty
Risk -- Profit

The following table represents the categories of resources used in a business.

The following table indicates which of the following categories are summarized on the business' balance sheet. The other seven cells in this table are not represented on the business' balance sheet.

The following table indicates which cells represent the returns reported on an income statement. Note, the business' net income is represented by the Owner's Return column.

The following table indicates which cells are included in the owner's return to asset (ROA). The return to the business' assets is represented as net income minus an opportunity cost for the owner's labor plus the interest paid to others. It is not clear whether an opportunity cost has been subtracted for the owner's information and risk.

The following table indicates which cells are included in the owner's return to equity (ROE). The return to the owner's equity is represented as net income minus an opportunity cost for the owner's labor. It is not clear whether an opportunity cost has been subtracted for the owner's information and risk.

In analyzing business profit, the owner needs to identify which resources the owner is contributing, the owner's opportunity cost for contributing those resources to the business, and whether the business' net income compensates for all of those opportunity costs.

Case Study (by Dr. Cole Gustafson, NDSU).

Each year during the annual meeting of the American Agricultural Economics Association, a pre-conference tour is arranged of surrounding agricultural firms.  At the 2006 meetings in Long Beach, California the tour visited an almond cooperative, winery, and strawberry farm.  The strawberry farm tour was particularily interesting because the operation was so different than a traditional midwest grain for livestock operation.

These differences were readily apparent as soon as we approached the farm.  The only building on the premises was a metal quonset with a small door for an office and larger garage door leading to storage.  No machinery was stored inside.  As we drove by, I could see a couple small tool boxes, but mostly pesticide boxes, plastic trays and boxes for picking, plastic sheeting, and other miscellaneous items.  There was no residence or farm house. 

Behind the quonset was the operation's machinery complement.  Most of the equipment was over 20 years old and very faded from sitting outside.  The largest tractor was a John Deere 4440 that pulled a 2-way 4-bottom plow and disk.  The remaining tractors were 50 hp all wheel drive units.  There were numerous sprayers and wagons.  The owner later remarked that all of the equipment was leased from his father and uncles.

As we proceeded to the field, the owner greeted us.  He appeard to be about 40 years old, dressed in jeans.  In the background were 20 hispanic workers planting new strawberry plants.  The field was perfectly level with hills every 20”.  Each hill had an irrigation line buried to provide water and was covered with black plastic.  The plastic was held down with dirt buried on its edges in the trench.  Periodically, holes were mechanically punched in the plastic and the workers were inserting new strawberry plants.

The owner explained that they plant several crops of strawberry plants each year.  Unlike midwest berries, they were not perrenials.  They were planted just for one harvest that was timed to provide produce for a delivery contract to major national grocery chain.

The farm was located next to other strawberry operations.  Climatic conditions in the region were very favorable for strawberry production.  The owner mentioned that there were 5 or 6 operations in the area and together, they were the nation’s largest supplier.  Each operation was about 150-200 acres.

Looking across the field, we could not help notice that the farm was adjacent to a recently developed strip mall.  Across the other side of the field was a new housing development.  In fact, the farm was nearly surrounded with commercial and residential development.  Other strawberry farms in the area faced similar development pressure.

The owner was asked how he survived this pressure. He indicated the farm’s land is all rented from a family now residing on the east coast.  Development rights for the property had been sold long ago, and the land is only taxed at its agricultural use value.  If sold, the land would bring $60,000 acre (agricultural value).  Annual rent for the land is $2,500/acre.

Next, the owner described the labor force.  The people in the field did not actually work for him directly.  He hired them through an agency.  There are so many issues involved with hiring migrant farm labor in California that specialized agencies have emerged to hire, train, and pay these people.  The owner was then immune from any immigation, work place safety, or compensation issues.

When asked about production inputs, the owner described the sequence of field operations and quantities of inputs applied.  However, he remarked that all of the inputs were provided by the contract buyer of the crop to insure traceability and that proper procedures were utilized.  In fact, the contract buyer specified all application rates and windows for application.

Who provided each of the economic resources?

• Who is providing the land?
• Who is providing the labor? Who is providing the management; that is, the decision making?
• Who is providing the capital? In what form is the capital being provided?
• Who is providing the information about production? Who is providing the information about marketing? In what form is the information being provided?
• What are the risks associated with this strawberry farm? Who is assuming these risks? How are some of these risks being managed?
• Based on the answer to these questions, what economic resources is the farm owner providing? Is it appropriate to consider this person as the "owner" of the farm business? Why?
• Based on the answer to these questions, who is entitled to which economic returns? Why?
• What are your observations about this business structure? Is this structure a trend for agriculture into the future? Why?

Summary

The person who contributes or provides an economic resource is entitled to be compensated. It may be helpful to identify who is contributing which resources to a business venture and then determine the appropriate compensation for that contribution. A challenge, however, can be identifying who is making the contribution, e.g., who is providing the market and production information, who assuming the risk(s), who is providing the capital? This challenge is further complicated because these economic resources can come in various forms.

Last Updated October 2, 2008

Email: David.Saxowsky@ndsu.edu

This material is intended for educational purposes only. It is not a substitute for competent professional advice. Seek appropriate advice for answers to your specific questions.

E-Mail:sswandal@ndsuext.nodak.edu
Published by Agricusiness and Applied Economics
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