ECO 365 Week 3 Production and Costs Example

What It Costs to Produce a Dozen Eggs: Fixed and Variable Costs, Marginal Cost, Economies of Scale and the Cage-Free Conversion at an Iowa Layer Farm

[Student Name]

University of Phoenix

ECO/365: Principles of Microeconomics

Week 3 Assignment

[Instructor Name]

[Date]

Prairie Hill Farms and all figures are composites written for a model paper; cost concepts and research findings come from the sources listed and are stated generally.

Prairie Hill Farms, a composite egg producer in northwest Iowa, keeps about 1.2 million laying hens in conventional cage housing and sells eggs to grocery distributors in the Midwest. Its flocks escaped the 2025 avian influenza outbreak, so it sold at record prices while infected neighbors restocked. Two questions now face its owners: how much to produce as prices fall back, and whether to spend about $50 million converting to cage-free housing to sell into states that require it. Both questions are answered by the farm's costs, which is where every supply curve begins. This paper analyzes them.

Production and Diminishing Returns

A production function links inputs to output. At Prairie Hill, output depends on hens, feed, barns and workers. Holding the number of barns fixed, adding hens raises output at first, but crowding eventually lowers each hen's production and raises mortality, so each additional hen adds fewer eggs than the last. That is diminishing marginal returns, which occurs whenever more of a variable input is added to a fixed one (Mankiw, 2021).

Fixed and Variable Costs

Fixed costs do not change with output in the short run: depreciation and interest on barns and equipment, insurance, property taxes and salaried managers, about $9 million a year at Prairie Hill. Variable costs rise with output: feed, the largest cost, replacement pullets, packaging, utilities and hourly labor, about 78 cents per dozen. At a full output of about 29 million dozen a year, total cost is about $31.6 million.

Average Total Cost at Three Output Levels

Average total cost is total cost divided by output. At 20 million dozen, it is about $1.23 per dozen; at 24 million, about $1.16; at 29 million, about $1.09. Spreading the fixed costs over more output lowers the average, which is why the farm runs its barns full whenever it can. Average variable cost stays near 78 cents across this range, while average fixed cost falls from 45 cents to 31 cents.

Marginal Cost

Marginal cost is the cost of one more dozen. Within the farm's capacity, it is close to the variable cost of about 78 cents, since adding output means more feed and packaging but no new barns. Beyond capacity, adding hens to full barns raises mortality and lowers eggs per hen, so marginal cost rises sharply. That rising marginal cost is why the farm's short-run supply curve slopes upward steeply once barns are full.

The Shutdown Rule

In the short run, a farm should keep producing as long as the price it receives covers average variable cost, because it must pay fixed costs whether it produces or not. With wholesale egg prices well above $1.09 during 2025, Prairie Hill earned large profits. Even if wholesale prices fell to 90 cents, below average total cost, it would continue producing, since 90 cents covers its 78-cent variable cost and contributes 12 cents per dozen toward fixed costs. Only below 78 cents would a temporary shutdown, such as an early flock sale, make sense.

Short Run and Long Run

In the short run, barns are fixed. In the long run, all costs are variable: the farm can build, sell or convert barns. Long-run decisions compare expected prices with long-run average cost, including a return on the capital invested.

Economies of Scale

Egg production shows strong economies of scale. Large farms spread the fixed costs of automated feeding, egg collection and grading equipment over more hens, buy feed in bulk and run their own feed mills. A farm of 100,000 hens might have average costs 20 or 30 cents per dozen higher than Prairie Hill. Those economies explain why most U.S. eggs come from large operations. Diseconomies can appear when very large concentrations of hens raise disease risk, as avian influenza showed: one detection can destroy millions of birds at a single site.

The Cage-Free Decision

Several states, including California and Massachusetts, require that eggs sold within their borders come from cage-free hens. Converting Prairie Hill would cost about $50 million, roughly $42 per hen, because cage-free barns hold fewer hens per square foot. Sumner et al. (2011) found that alternative housing systems raise production costs substantially, reflecting more space, more labor and higher mortality. At Prairie Hill, managers estimate cage-free eggs would cost about 30 cents more per dozen, raising average total cost to about $1.40.

Will It Pay?

Cage-free eggs sell at a premium in states requiring them and to food companies that have pledged to buy them. If Prairie Hill could sell all its output at a premium of 45 cents per dozen above conventional prices, the 15-cent margin over the added cost, on 26 million dozen a year at the lower stocking density, would yield about $3.9 million a year, paying back the conversion in about 13 years before financing costs. A smaller premium would not justify the investment. The decision depends on the long-run price premium, which in turn depends on how many other producers convert.

The Cost of Disease Risk

Avian influenza adds a cost that does not appear in an ordinary cost table. If Prairie Hill's flock were infected, the farm would lose its hens, its income for months and the cost of cleaning and restocking, offset partly by government indemnity payments for destroyed birds. Managers estimate the annual chance of infection at a few percent, so the expected cost is modest, but the potential loss is large. The farm spends about 4 cents a dozen on biosecurity: showers for workers, truck washing and rodent control. Those spending choices treat disease risk as a real cost, one that grows with the concentration of hens in one place.

Effect on Supply

If many farms convert, supply of cage-free eggs rises and the premium shrinks, while the higher cost per dozen raises the long-run equilibrium price of eggs. Mullally and Lusk (2018) estimated that California's housing rules raised egg prices in the state, consistent with higher costs shifting supply upward.

Conclusion

Prairie Hill's fixed costs make full barns valuable, its low variable costs keep it producing even if prices fall below average total cost and its scale gives it a cost advantage that also concentrates disease risk. Converting to cage-free housing raises costs by about 30 cents a dozen and pays only if a lasting premium of about 45 cents or more holds, a decision that depends on how many rivals make the same choice.

References

Mankiw, N. G. (2021). Principles of microeconomics (9th ed.). Cengage.

Mullally, C., & Lusk, J. L. (2018). The impact of farm animal housing restrictions on egg prices, consumer welfare, and production in California. American Journal of Agricultural Economics, 100(3), 649-669. https://doi.org/10.1093/ajae/aax049

Sumner, D. A., Gow, H., Hayes, D., Matthews, W., Norwood, B., Rosen-Molina, J. T., & Thurman, W. (2011). Economic and market issues on the sustainability of egg production in the United States: Analysis of alternative production systems. Poultry Science, 90(1), 241-250. https://doi.org/10.3382/ps.2010-00822