Expenditure Constraints and Profit Maximization in U.S. Agriculture: Comment

Abstract

In a recent (1986) paper, Lee and Chambers (hereafter LC) developed a model of expenditure constrained profit maximization. A single constraint was specified for the purchase of all variable inputs, and the competing hypotheses of unconstrained and constrained profit maximization were tested in terms of corresponding nonnested homogeneity conditions. LC proceeded in terms of a profit function with prices normalized on the predetermined level of expenditure. In this comment, an alternative formulation of the expenditure constrained profit function is presented. The advantages over the LC approach are twofold. First, the nested relationship between the hypotheses of unconstrained and expenditure-constrained profit maximization is apparent. This permits simple nested tests of the full consequences of the alternative models. Second, this alternative formulation can readily incorporate situations whereby expenditure constraints are input specific. For example, farmers typically negotiate separate loans for the purchases of operating inputs and capital inputs. Different expenditure constraints may have different impacts on incomes. Furthermore, input-specific foreign exchange constraints on production are easily incorporated into this formulation of the expenditure-constrained firm. The importance of modeling the effects of foreign exchange constraints on production in developing countries is well recognized (Dervis, de Melo, and Robinson); however, to date, econometric models of producer behavior have not incorporated the impacts of foreign exchange constraints in a consistent manner (e.g., Kohli, Diewert and Morrison).