277 – Perfection isn’t best

In whatever work we do, a common challenge is deciding how much effort to devote to a particular task. Additional effort will usually generate more output or better-quality output, but at what point does the cost of extra effort outweigh the benefits? It might be a lower point than you think.

A standard model from production economics provides some useful insights into this issue. The model represents a firm’s decision making about a production input. A classic example from agriculture is a farmer’s decision about how much fertiliser to apply to a wheat crop. I’ll go through this example and explain the insights it gives us. Later on, I’ll show how the same insights are often relevant to completely different types of work, such as writing a report or studying for an exam.

Looking at the fertiliser example for now, the question is, how much fertiliser should a farmer apply in order to get the outcome that is best overall?

The higher the rate of fertiliser applied, the higher the level of wheat production. However, the relationship between the input (fertiliser) and the output (wheat grain) is unlikely to be a straight line. It’s more likely to be shaped like Figure 1: as the level of input increases, the level of output increases but it tends to flatten out. Whatever its shape, economists call the relationship between an input and an output a “production function”.

pd277f1

Figure 1. A production function for fertiliser applied to a wheat crop.

 

Suppose the planned level of fertiliser in Figure 1 is low – say 20 kg/ha. As the graph shows, if the farmer increased the rate from 20 to 40 kg/ha, there would be quite a large increase in wheat yield. On the other hand, if the planned fertiliser rate was 120 kg/ha, increasing it by another 20 kg/ha would increase yield by only a small amount. At 200 kg/ha, a further increase in fertiliser would make no difference to yield (in this example).

There have been countless thousands of fertiliser trials conducted around the world, and the great majority show a shape like Figure 1 – steep at low fertiliser rates, flat at high rates.

One possible answer to the question, “what is the best rate of fertiliser?” would be, “the rate that gives the highest yield”. In Figure 1, the yield is maximised at 200 kg/ha.

The problem with this answer is that it ignores the cost of the input. Clearly, fertiliser is not costless.

Figure 2 shows the farmer’s revenue from the harvested wheat crop and the cost of the fertiliser that has been applied (all calculated per hectare). The revenue curve is the crop’s yield (from Figure 1) multiplied by its sale price (which I’ve assumed is $250 per tonne in this example). The cost curve is the cost of fertiliser ($1.90 per kg) times the rate of fertiliser applied.

pd277f2

Figure 2. Revenue and cost from wheat production at different fertiliser rates.

 

At any fertiliser rate, the benefit to the farmer (the profit) is the revenue received minus the cost of fertiliser. On the graph, the profit at a particular fertiliser rate is the vertical distance between the revenue and cost line at that fertiliser rate. You can see that if no fertiliser was applied, the benefit would be $300 per ha (the distance between the red and blue lines at the points where they hit the vertical axis, where fertiliser rate is zero). If the fertiliser rate was 80 (where the dashed line is), the vertical distance between the red and blue lines is a bit over $500, so 80 is clearly a better option than zero. At rates above 80, the revenue and cost lines get closer together, meaning that the overall benefit is less than at 80. In fact, 80 is the best possible input level in this example. It gives the highest profit to the farmer.

Figure 3 shows the farmer’s profit at different fertiliser rates. It is the difference between the two lines in Figure 2. In this graph it’s easy to see that the maximum profit is generated at 80 kg per ha of fertiliser.

pd277f3

Figure 3. Profit from wheat production at different fertiliser rates.

 

It’s also easy to see that the fertiliser rate that maximises crop yield (200 kg/ha) is not the rate that maximises profit. The reason for this is that, at rates above 80 kg/ha, the revenue from the additional grain isn’t enough to cover the cost of the additional fertiliser. In fact, at 190 kg/ha, increasing the fertiliser rate up to 200 kg/ha gives basically no additional yield at all, only additional costs (see Figure 1).

Figure 3 also shows that the profit function is quite flat in the vicinity of the optimum (80 kg/ha). Any rate between say 60 and 100 kg/ha gives very nearly as much profit as does 80 kg/ha. (See PD#88)

As promised earlier, let’s look at other types of outputs and inputs and see how this model is relevant. Economists have found that the shape of Figure 1 (or something like it) is relevant to many types of physical production processes. Just Google “production function” and you’ll see that this is the default assumption in the absence of evidence to the contrary. In all these cases, the optimal input level is less than the level that maximises output, and there is a range of input levels that are almost as good as the optimum.

What about work that doesn’t create physical products? In most developed countries, the service sector constitutes 70 to 80% of the economy. How relevant are the above conclusions to activities in that sector, like analysing some data, writing a report, marketing a product, or designing a building?

My proposition is that the shape of the production function in Figure 1 is very often relevant to these sorts of activities as well as to physical production processes. Consider the process of writing a report. It’s a common experience to find that one can prepare a report to a reasonable standard with a moderate amount of work, but further improvements in the standard of work take increasing amounts of work. As the report approaches perfection, there is a risk of continuing to work on it almost indefinitely without any real improvement in its quality. Clearly, this is just like the fertiliser example, with the main difference being that I’m focusing on the quality of the output rather than its quantity.

If that’s so, then it must also be true that the ideal level of effort to put into this type of work is less than the amount needed to produce a perfect report. Aiming for a 98% or even 95% perfect job (rather than 100%) will produce an output that is good enough in the majority of cases, and will allow you to move on more quickly to other work. For some people, adopting this as a conscious strategy can greatly increase their efficiency at work, especially people with strong perfectionist tendencies.

Of course, sometimes 95% really isn’t good enough. If a report is particularly important and will be carefully scrutinised, you might decide to aim for 99.9%, but even in these special cases, it is unlikely to be optimal to aim for 100%.

Further reading

Pannell, D.J. (2006). Flat-earth economics: The far-reaching consequences of flat payoff functions in economic decision making, Review of Agricultural Economics 28(4), 553-566. Prepublication version here (44K). IDEAS page here.

 

276 – MOOC

A MOOC is a “Massive Open Online Course”. They are free to enrol in, and they are very popular, often attracting thousands of participants. I’ve prepared a MOOC on “Agriculture, Economics and Nature”, for which registrations are now open. 

About a year ago I was introduced to the CEO of Yara Pilbara, the Western Australian arm of a major international fertilizer company headquartered in Norway. He was keen to establish a partnership with the University of Western Australia and to contribute financially to a venture that would benefit the University and would be consistent with Yara’s values and interests.

After discussing some options, I agreed to lead the development and delivery of a MOOC on the economics of agriculture and the environment. Preparation of the course is now almost complete, and it will be offered for the first time starting on February 2, running for six weeks. I’m hoping that you’ll consider signing up to do the course, or perhaps recommending it to others. You can join the 1000 people from about 50 countries who have already registered.

Here are some more details so that you know what you’d be getting into if you did the course.

It doesn’t require any prior knowledge of agriculture or of economics, and is pitched at about the level of upper high school or first year university. I’m hoping that it will be of wide interest.

Each week has a different theme:

  1. Agricultural production and prices, and agriculture’s reliance on natural resources
  2. Resource and environmental challenges facing agriculture
  3. The economics of agricultural inputs
  4. The economics of land conservation
  5. The economics of agri-environmental projects
  6. Government policies in agriculture

There are 8-10 brief videos to watch each week, mostly 5 to 7 minutes long. There are two or three recommended readings each week, each of them brief and non-technical. There will be a brief online quiz each week so that you can check that you’ve understood the material, and a multiple choice exam at the end. Pass the exam and you’ll receive a certificate. The course is stand-alone and doesn’t give you credit for any other course at the University of Western Australia.

There will be opportunities to interact with other students from around the world in forums on the course web site. My assistant and I will also participate in these forums to help people with their problems and questions.

A very basic ability with maths is needed. You’ll need to be able to read and interpret a line graph, and there are a couple of optional spreadsheet exercises that you can choose to do.

I’m estimating that the work load for students will be about 2 hours per week, although you can obviously spend more time reading more deeply on each of the topics if you choose to.

For me, the aim in presenting the course is to raise awareness of the School of Agricultural and Resource Economics at UWA. Perhaps it will lead to students enrolling in our other courses.

Yara is involved to make a contribution to the community and to generate positive publicity and public relations. Yara assured me that they would not try to influence the content of the course, and they certainly have stuck to that.

For students, the potential benefits include learning interesting information about the economics of agriculture and the environment, assessing whether you might be interested in doing further study in this area, and interacting with others online as part of the course.

The financial support allowed us to pay for professional-quality production, design and editing for the videos that make up the core of the course. I’m confident this will improve the experience of students compared to some of the very cheaply produced MOOCs that are available.

For more information, or to register for the course, go to this page, or take a look at the promo video below.

If you watch the promo above, I hope you like the theme music. I recorded three different version of it in my studio (my backyard shed, actually), and they’ll be used in different weeks of the course.