natural resources, the environment and agriculture chapter 10

Natural Resources,the Environmentand Agriculture

Chapter 10

Topics of Discussion

Agriculture and the environmentValuation of non-market goodsEconomics of soil conservationGovernment policies for agriculture,

natural resources, and the environment

2

Agriculture and the Environment

Water pollutionNon-point source

Fertilizer run-off from croplandPoint source

Manure pit overflow/leak

Air pollutionDispersed agricultural industry Markets have become more distant

Dairy industry increased reliance on foreign markets

Distant markets require extension transportation system to obtain goods

Pages 171-1763

4


Above Ground Manure Pit

Manure Runoff and Soil LossHog Manure Spill, Clay Cty, KY


Global climate changeImpacts of changes in rainfall

patternsImpacts of temperature changes

Other environmental impactsOdor from CAFO (Concentrated

Animal Feeding Operations)

Pages 171-1765


6


7

Economics of the EnvironmentFrom Ch. 8 we saw that if an economy is

fully efficient then Private actions of consumers and producers

will maximize total surplus Referred to as being Pareto Efficient

Can the same be said for environmental impacts of economic activity? Is the efficient level of environmental

impacts being generated?

Pages 1778

Economics of the Environment

Does the environment have value? Example of the impacts of water pollution Users of a particular water resource would

be willing to pay (WTP) something to reduce (abate) the level of pollution

→ Implicit demand for environmental improvements Demand curve for pollution abatement? Similar to market commodities

Page 1779

Economics of the Environment Are there costs associated with reducing the

level of environmental pollution? Install scrubbers on power plant

smokestacks (i.e. Charter St. power plant) Use more expensive lower sulphar coal The above implies that there is a supply

curve (MC curve) for pollution abatement

What is the socially optimal level of pollution abatement? Should pollution be reduced to 0?

Page 17710

WTP

MC

PollutionAbatement (Reduction)

$

P1

C1

A1 A3

At A1, ↑ abatement (↓pollution) would cost C1 but public would be willing to pay P1

If WTP > MC then society’s net benefit will be increased by increasing abatement


Socially efficientabatement level

Socially efficientabatement level

A2

C2

P2

C3

P3

A4

At A4 too much abatement, Why?

At A4 too much abatement, Why?

11

WTP → Demandcurve for pollutionabatement

Unlike typical market goods such as food, clothes, etc. We cannot use market information to determine

value of pollution abatement WTP is obtained using a variety of procedures

generally referred to as non-market valuation techniques

Will a market develop for environmental improvement and socially optimal outcome? Usually not because the characteristics of

efficient property rights are not satisfied for environmental goods


12

Efficient Property RightsEfficient property rights are characteristics

that ensure a socially optimal provision of goods and services will be providedProperty rights: Privileges and limitations that

are associated with the ownership of a resourceEnforceability: Can enforce individual property

rightsTransferability: One is able to transfer property

rights from one individual to anotherExclusivity: All associated benefits and costs are

received by only one individual at a timePages 178-17913

Efficient Property RightsEnforceability: security of individual rights

If not present then there is nothing to stop someone from taking the good from its owner

No one would produce the good as not assured will get paid

No one would purchase because they could take without paying or it could be taken without permission

Pages 178-17914

Efficient Property RightsTransferability: Property can be

transferred from one individual to anotherExample is laws prohibiting the sale of certain

goods Sale of goods made of ivory from endangered

speciesNo markets will arise because sale is not

allowedEfficient transfer from one individual to

another cannot occur

Pages 178-17915

Efficient Property RightsExclusivity: All associated benefits and

costs are received by only one individual at a timeOne example of this not existing when

some costs are not borne by the producer of the good but by the public at large

Pages 178-17916

Efficient Property RightsExclusivity: All associated benefits and

costs are received by only one individual at a timeExample of agricultural production

Farmer pays for labor, capital and material inputs

Producer does not pay for the negative impacts downstream when runoff causes a degradation in water quality such as reduced fishing quality

This downstream impact passed onto the public is referred to as an externality as the producer of the impact does not pay for its cost

Pages 178-17917

Concept of ExternalityExternality

There exists positive as well as negative externalities

Example of positive externality: Honey producer’s impact on neighbors' apple crop

Example of negative externality: Playing loud music in your apartment to the point that it wakes your neighbors

Pages 178-17918

Concept of Externality

Q

$

D

C

B

A6

15

Pm

Qm

Below represents aggregate market demand and supply for good, Q

Sm=MCm

Dm

Total willingness to pay = A + B + C + D

Producer surplus = BConsumer surplus = C

+ DTotal (societal) surplus

is B + C + D

19

Concept of ExternalitySuppose the production of Q causes

pollution Assume pollution imposes costs on others

due to degradation of water resources Neither producers nor consumers of this

good takes these costs into account i.e. are external to the market

For simplicity lets assume these external costs (Ex) are constant at $9/unit of Q

The social marginal cost (MCS) per unit of production is: MCS = MCm + Ex

20


Q

$

C

B

6

15

Pm

Qm

Ex = $9/unit of outputEx = $9/unit of output

Sm = MCm

MCS = MCm + Ex

Dm

The social marginal cost (MCS) is: MCS = MCm + Ex

With Qm units produced there is additional cost

= Qm * Ex = area (B + C + E)

E

21

D

A


Q

$

D E

C

B

A6

15

Pm

Qm

Sm = MCm

MCS = MCm+Ex

Dm

From the market equilibrium the social net benefits (SNB) = CS + PS – External CostsSNB = (B + C + D) – (B + C + E) = D – E

CS + PS External Costs

Ex = $9/unit of outputEx = $9/unit of output


Q

$

DE

6

15

Qm

Sm = MCm

MCS = MCm+ Ex

Dm

How can we increase the SNB = (CS + PS – Externality)?What happens if we increase production to Qm*?What happens if we decrease production to Qm**?

F

G

Qm*→ SNB* = D – E –F – G → SNB* < SNBQm** → SNB** = D → SNB** > SNBAt Qm and Qm* production is inefficiently high relative to socially optimal, Qm**

Qm*→ SNB* = D – E –F – G → SNB* < SNBQm** → SNB** = D → SNB** > SNBAt Qm and Qm* production is inefficiently high relative to socially optimal, Qm**

Qm*Qm**

From above:SNB = D - E

From above:SNB = D - E


Q

$

Qm

Sm=MCm

MCS=MCm+Ex

Dm

We can also look at the above inefficiency relative the marginal (last) unit What are the marginal net benefits and marginal costs

of the last unit of Q purchased?At the market level of

production, Qm

Consumers willing to pay Pm

The cost to producers is Pm

→the SNB for the mth (i.e., last) unit purchased is 0

MCM =Pm

Pm


Q

$

Qm

Sm=MCm

MCS=MCm+Ex

Dm

We can also look at the above inefficiency relative the marginal (last) unit What are the marginal net benefits and marginal costs

of the last unit of Q purchased?

There are additional social costs (area E)

→the marginal SNB for the last unit purchased is (WTP – MCm – Ex ) where we assumed Ex=$9 per unit of Q

Pm

E


From the above we can conclude the following: In the presence of externalities the free market

will not produce socially optimal level of output Referred to as an example of market failure Negative externality → produce too much of the good

Although production of Q results in an externality this does not mean that production should be set to 0 Reducing production to 0 is socially inefficient At social optimal production level, SNB may be

positive even after subtracting external costs, Ex

Environmental Policies

As noted above, an externality results in a market failure as too much production occurs If responsibility for damages could be established and

enforced then a market for damage abatement would arise

Example:A dairy farmer who has a pasture that borders a Class

I trout stream and generates some non-point manure run-off into the stream

Local Trout Unlimited club wants the loadings to be reduced to ensure a self-reproducing trout population

The following is an example of a “Coase” market-based approach to solving the negative externality problem

Pages 180-183


Pages 180-183

TU: “We are 140,000 conservation minded anglers united behind a simple philosophy: take care of the fish, and the fishing will take care of itself.”


The Coase Theorem Attributed to British economist Ronald Coase Describes the economic efficiency of an

economic outcome in presence of externalities → When trade in an externality is possible,

bargaining (without transaction costs) will lead to efficient outcome

In practice, obstacles to bargaining or poorly defined property rights can prevent Coasian bargaining

Pages 180-18329

Environmental PoliciesDairy farmer/Trout Unlimited example

Pages 180-183

Q

$

Qm

Sm=MCm

MCS=MCm+Ex

Qm*

Qm* is socially optimal pollution for farm

Area C is the externality (cost) of producing Qm

Trout Unlimited offers a bribe of C + D to produce Qm*

PS w/o payment = A + B + D w/payment = A+B+C+D

Social Net benefits Qm = A – CQ* = A

A

B

D

C


Coase’s approach has not been widely adopted due to the free-rider problem Suppose Trout Unlimited decides to pay upstream

polluters not to pollute Although only Trout Unlimited members pay into

the fund, all fishermen whether a member of not benefits from cleaner water

→A strong incentive not to pay the cost of association membership while enjoying the benefits (i.e. to be a free-rider)

Pages 180-183

Environmental PoliciesGiven the difficulty of obtaining an

economic efficient level of environmental resources there are a number of types of public policies used to move toward this targetCommand-and-Control policiesTaxes and subsidiesTransferable rights

Pages 180-183

Environmental PoliciesCommand and Control: Environmental

policy consisting of regulations on technology or restrictions on practicesAll economic agents treated equally

All firms required to abate to the same level All must install same equipment

Problem is that it does not recognize the diversity in the economy and differential impacts of regulation

Example: In WI, not allowed to spread liquid manure on fields in winter due to frozen soil

Example: In Dane County cannot use phosphorous in fertilizer

Pages 180-18333

Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward

© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights Reserved.


Example: Two farmers and a requirement to reduce non-point pollutionProducer John uses older technology →

reducing pollution could be costlyProducer Sue uses newer technology →

reducing pollution achieved relatively cheaplyIf they are neighbors, same level of total

environmental improvement achieved at a lower total societal cost if: Producer Sue w/lower abatement cost reduces more Producer John w/higher abatement cost reduces less

by the additional abatement of Producer Sue

Pages 180-18334


Pages 180-183

Figures A & B represent the abatement MC for Firms 1 and 2MC ↑ with abatement level

Fig. C combines these two figuresD2 < D1 where each firm has 5 abatement units

$ $ $

A1 A2 A1

A2

MC1

MC2

MC2

MC1

5 10 5 10 5 10000

0510

$

35

D2

D1

A B C


Pages 180-183

Movement to the right (left) would ↑ (↓) abatement for Firm 1 and ↓ (↑) abatement of Firm 2

Assume we want total abatement to equal 10 unitsFirm 1: 10 → Firm 2: 0Firm 1: 0 → Firm 2: 10Firm 1: 5 → Firm 2: 5Firm 1: 4 → Firm 2: 6

36

D1,4: MC of firm 1 for 4 units of abatementD2,6: MC of firm 2 for 6 units of abatement

$

A1

A2

MC2

MC1

4 100

0610

$

5

5

D1,4

D2,6

If A1 = A2 = 5 units the total abatement cost (TAC) is:TAC = A + B + C

Firm 1’s last unit of abatement cost much higher than the last unit of Firm 2’s abatement Difference = MC1*- MC2*→ that TAC could be reduced if

Firm 2 abates more, Firm 1 less TAC is minimized when MC1 = MC2 A1=3, A2=7 TAC reduced by area F

The gov’t could make such an allocation but would have to know the MC curves

B


Pages 180-183

$

A1

A2

MC2

MC1

5 100

0510

A C

Firm 1 Firm 2MC1*

MC2*

3

7

F



TAC reduced if Firm 2 abates more, Firm 1 lessTAC is minimized when MC1 = MC2 (i.e., TAC*)

TAC* = D + E TAC - TAC* = B = amount cost reduced for same total economy

abatement (10)

Each firm could be assigned firm-specific targetsWould have to know the MC curves of each firm


Pages 180-183

$

A1

A2

MC2

MC1

5 100

0510

A

B

C

MC1*

MC2*

38

$

A1

A2

MC2

MC1

5 100

0510

MC*TAC=A+C+B

D E

TAC*= D+E

How do I know that A + C = D + E?

Environmental PoliciesTaxes and Subsidies: An incentive-

based approach to environmental policySubsidy: Promote abatementTax: Penalize for pollution

Assume we have a subsidy of S dollars on pollution abatement to minimize TAC

Firm 1 will abate 3 units,Firm 2 will abate 7 unitsA1 < 3 → MC1 < S, A2 > 7 → MC2 > SA1 > 3 → MC1 > S, A2 < 7 → MC2 < SA1 = 3 & A2 = 7 → MC1 = MC2 = S

Pages 180-183

$

A1

A2

MC2

MC1

5 100

0510

3

S

7

39

Environmental PoliciesA tax on pollution would work just like a

subsidy on pollution abatementA tax of $T per unit of pollution

→ each unit of abatement saves the firm $TThe firm will continue to abate as long as

the tax savings are ≥ MC of abatingOne could also tax the output whose

production generates the pollution $T*/unit of outputShifts up the firm’s (industry’s) marginal

cost curve Pages 180-18340



Environmental PoliciesA tax on output (Pigovian Tax)would

shift up the marginal cost curve

Pages 180-18341

$

Qm

Sm

MCS=MCm+ T*

Dm

T*

Qm*

Pm*

Pm

A

BC

D

E

F

Price increase ≠ T*Impact on producers vs.

consumers?PS ↓ from A+F to CCS ↓ from B+C+D+E to DAmount of tax collected = A

+ BDeadweight loss to society

of Pogovian tax = E+FTax collected = A + B



Environmental PoliciesDifficulty with Pigovian tax is setting

tax rate to counterbalance negative externality effects$T* = $Ex?Tax revenue used to pay damages of the

externalityLobbying of gov’t by polluters

↓ of tax rate ↓ mitigating effect of the taxSub-optimal solution from society’s

perspective

Pages 180-18342


Advantage of tax/subsidy: Whatever abatement level is achieved it will be done at the lowest total cost across all agents (for society as a whole)

Disadvantage of tax/subsidy: Unless firm specific MC curves known, will not know with certainty the abatement level achievedT too low, too little abatementT too high, too much abatement

Pages 180-18343


Transferable Rights: When applied to pollution known as transferable discharge permits (TDP)

Under a TDP program rights to pollute can be bought and sold by pollutersMoves the permits to those polluters with

relatively high abatement costsAs long as aggregate pollution level stays below

the target, the gov’t does not worry who is polluting

Pages 180-183


TDP Example: Firm 1 and Firm 2 are required to do 5 units of abatement

MC1 > MC2 at this levelA trade could work out

where Firm 1 could pay Firm 2 for a permitFirm 1 ↑ pollutionFirm 2 ↓ pollution

Permits could continue until MC1 = MC2 Pages 180-183

$

A1

A2

MC2

MC1

5 100

0510


Advantage of a Transferable Rights program:Are cost effective given the least cost of TCP

could be achievedGov’t can control level of pollution and leave

the allocation up to the marketplace

Pages 180-183

Natural Resources and Agriculture

Distinction between environmental issues and natural resource issues: The extent to which externalities exist Environmental issues: Important

externalities present Natural Resource issues: Costs and Benefits

of natural resource use falls mainly on the user

Lets look at the example of soil quantity and quality

Pages 183-187

Economics of Soil UseFarmer undertakes efforts to prevent soil

erosion so as to protect its quality Soil quality a fundamental issue in agriculture An asset with potentially long productive

lifetime

Major source of decline in soil quality is soil erosion resulting from rain or wind Erosion can wash away productive soil Can also degrade features of the soil that are

essential for crop productivity Soil nutrients

Pages 183-187

Economics of Soil UseSoil quality is a complex function of

physical (i.e., depth), chemical (i.e., acidity) and biological (i.e., microbial activity) What is the value of this resource? How much should be spent on preserving it?

A farmer values soil because it has the potential to generate a positive income stream over time Important question: What is the value of this

future income worth?

Pages 183-187

Discounting and Present Value

Example of 5 years of $100/year net income from an acre of land each year → total net income of $500 Not accurate that this $500 of future income is

worth $500 today, need to wait to receive it Would you prefer to wait for 3 years for $100

or receive $75 today? General principle: The further in the future

income is generated, the less it is worth today

Pages 183-187

To compare $ values over time economists use discounting to convert all $ to present values Present value: Amount of money an individual

could be given today that would make him/her indifferent to a greater amount of income in the future

What is the opportunity cost today of that future income?

Pages 183-187


Suppose you purchase a certificate of deposit today for $6 with an interest rate of 5% annually In 5 years that $6 would have grown due to

compound interest to $8.04 $8.04 = $6 x (1.05)5

You would be indifferent between $8.04 5-years from now and $6 today

The present value (PV) of $8.04 5-years from now given the 5% interest rate is $6.00

Pages 183-187


Initial deposit Number of years

Interest rate

What is the present value of $10 5-years from now with a 6% interest rate?

From the above we know that:$10=$X x (1.06)5

→ $X = $10 ÷ [(1.06)5] = $7.47 →$7.47 is the PV of $10 5-years from now and

given a 6% interest rate Present value should always be < future value with a

positive interest rate →Opportunity cost of $10 5 years from now is

$7.47 given the above interest rate Pages 183-187


Returning to our farm example:You have an acre of land that generates a

stream of income over time The PV of this stream would be the amount

of money the farmer would have to be paid now that would be equivalent to this stream of future income

The total PV of the stream would equal the sum of the PV’s of the individual elements of this future stream

Pages 183-187


Lets represent some unknown interest rate by the symbol ρ

If we have a level of income in year t represented by Yt, the PV of the stream of income (V) is:

Pages 183-187


31 2

1 2 3

YY YV

1 ρ 1 ρ 1 ρ

PV of yr 1income PV of yr 2

income

PV of yr 3income

Given the above assume: The farmer receives the same level of income

each year (Y*) This income is generated for a very large

number of years There is a mathematical result that the PV of

this sum over a large number of years (V*) will be approximately equal to:

V* is referred to as the capitalized value of the constant income stream, $Y* given interest rate ρ

Pages 183-187


** Y

Vρ

Going back to our soil example Y* earned each year from an acre of land Capitalized value of this stream of income

needs to be shared with all inputs used to generate this income Fertilizer, seed, tractor time, management, etc.

How can we determine the marginal value of the soil? What is the value of the last unit of soil added to the

generation of the above income? Page 186 in the text shows how to undertake such

an evaluation

Pages 183-187

Economics of Soil Use

Going back to our soil example Suppose the yearly profits is $10/year/acre and

ρ = 5% Capitalized Value = $10/(5/100)=$200 What is the marginal value of his soil given

other inputs used?

The next year, there was a change in tillage practices that resulted in unanticipated and significant erosion events → loss of $1/acre in return

Pages 183-187


The capitilized value of the now $9/acre return is 9/(5/100)=$180 →The value of soil conservation efforts is $20

($200 - $180) How does this value compare to conservation

effort costs?

Pages 183-187


A characteristic of surface water (i.e., lakes, rivers) are that they are typically renewed over time via rainfall and runoff

Important question for economists: How are these water resources to be allocated among competing uses? i.e., agricultural irrigation, residential use,

industrial use, recreation, etc.

Pages 187-189

Water as an Asset

“The State Water Board’s mission is to preserve, enhance and restore the quality of California’s water resources, and ensure their proper allocation and efficient use for the benefit of present and future generations.”…Mission Statement, CA State Water Resources Control Board,

CA Environmental Protection Agency

Pages 187-189

Water as an Asset

Water as an AssetWe have two farmers who are competing

for the use of a river’s water for irrigation Assume that a total of 100 acre-feet are allowed

to be extracted Applying irrigation water

increases crop yield The marginal revenue of water

and marginal cost of pumping aresuch that both farmers would like to use 80 acre feet of water But there is only 100 acre-feet

Pages 187-189

Water as an AssetOne farmer is upstream of the other

Will use 80 acre-feet of water → Only 20 acre-feet for downstream farmer

Pages 187-189

Irrigation Marginal Revenue and Marginal Cost

Irrigation Marginal Revenue and Marginal Cost

Both farmers havethe same revenueand cost curves

Both farmers havethe same revenueand cost curves

Upstream farmer

Downstream farmer

8020

MC

MR

MR = Implied value of one more unit of water

MC = Cost of producingone more unit of water

100

$

Water as an AssetThe 80/20 allocation is

economically inefficient Marginal Value of another

unit of water = 0 for upstream farmer as MR=MC

Marginal Value of another unit of water for downstream farmer > 0 = ($A – $C) per unit→ Total excess value =ABDC

→Total net benefits could be ↑ by allocating water from upstream to downstream farmer

Pages 187-189

Downstream farmer

8020

MC

MR

100

Upstream farmer

A

C

$

B

D

Water as an AssetIf the water rights are transferable

Downstream farmer would be willing to pay more for an additional unit of water than upstream farmer values the marginal unit of water

→ A deal could be made such that both are better off

Ideally, the farmers would bargain back and forth until each had 50 acre-ft of waterThis result is due to the assumed cost and

revenue structures being the same across farmers

Pages 187-189

Water as an AssetGiven the assumption of equal cost and

revenue structures for both farmersTotal net benefits would be maximized where

the net benefits of an additional water unit would be the same for both farmers

→A system in which upstream users have preference over downstream users can result in an inefficient water allocation

Pages 187-189

SummaryEconomists play a role in designing policies

that affect the environment and natural resources

Incentives matter when designing policies to achieve desired objectives

For agricultural production, water and soil are assets that have value and net benefits associated with their use

Chapter 11 is used to discuss forms of governmental intervention, including price and income supports that impact agricultural markets…

natural resources, the environment and agriculture chapter 10

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