Decision‐making Criteria for Purchasing Milk Quota at the Individual Farm Level

Abstract

SummaryDairy farmers wishing to contemplate purchases of additional quota should first consider what the appropriate time horizon on their investment should be. If the chosen time horizon is one year or less, the problem of estimating how much they can afford to bid for quota can be solved with simple budgeting techniques. On the other hand, if the time horizon is taken as several years, and this would seem rational, then capital budgeting techniques are required. However, in either case, investment in additional quota should be compared with alternative investment opportunities before a final decision is made.Where capital budgeting techniques are used, a modification of the net present value approach permits the farmer to take account of his time preference for money, and allows calculation of the break‐even price, or the maximum affordable price to pay for additional quota. This approach necessitates the provision of estimates of the expected net returns from investing in quota for each year of the selected time horizon, as well as provision of estimates of the salvage value of the quota and an appropriate discount rate. The calculation of the expected net returns figures represents the most difficult task for the farmer. If expansion of milk shipments rests upon increasing output of milk per cow, then the short‐run production function and marginal cost curve provide the appropriate reference points. The expected net return on investment in quota is then given by the area under the marginal revenue line and above the relevant portion of the marginal cost curve.If, however, all short‐run variable input decisions have already been implemented at the optimum level, and expansion of milk shipments depends upon expanding the number of cows, or the “fixed” plant and equipment, or both, then the average total cost curve is the appropriate reference point. The expected net return on investment in quota is then represented by the difference between total net revenue at the new planned level of output and total net revenue at the existing level of output.