Explanation:

How is this MSPs being fixed?

• Recommendation: The Commission for Agricultural Costs & Prices (CACP) in the Ministry of Agriculture would recommend MSPs. 
• For 23 crops: These include 14 grown during the kharif or post-monsoon season and six in rabi or winter (wheat, barley, chana, masur, mustard and safflower), apart from sugarcane, jute and copra. 

Factors considered: The CACP considered various factors while recommending the MSP for a commodity, including cost of cultivation. It also took into account 

• The supply and demand situation for the commodity. 

Market price trends (domestic and global) and parity vis-à-vis other crops and 

• Implications for consumers (inflation), environment (soil and water use) and terms of trade between agriculture and non-agriculture sectors. 

Changes with the 2018 budget

• MSPs would henceforth be fixed at 1.5 times of the production costs for crops as a predetermined principle. 
• The CACP’s job now was only to estimate production costs for a season and recommend the MSPs by applying the 1.5-times formula. 

How was this production cost arrived at?: 

• The CACP does not do any field-based cost estimates. 
• It merely makes projections using state-wise, crop-specific production cost estimates provided by the Directorate of Economics & Statistics in the Agriculture Ministry (available with a three-year lag). 
• The CACP further projects three kinds of production cost for every crop (both at state and all-India average levels). 
• A2: It  covers all paid-out costs directly incurred by the farmer (in cash and kind) on seeds, fertilisers, pesticides, hired labour, leased-in land, fuel, irrigation, etc. 
• A2+FL: It includes A2 plus an imputed value of unpaid family labour. 
• C2: It is a more comprehensive cost that factors in rentals and interest forgone on owned land and fixed capital assets, on top of A2+FL.

Hence option 2nd is correct.