Natural Resources,
the Environment
and Agriculture
Chapter 10
Topics of Discussion
Agriculture and the environment
Valuation of non-market goods
Economics of soil conservation
Government policies for agriculture,
natural resources, and the
environment
2
Agriculture and the Environment
Water pollution
Non-point source
 Fertilizer run-off from cropland
Point source
 Manure pit overflow/leak
Air pollution
Dispersed agricultural industry
Markets have become more distant
 Dairy industry increased reliance on foreign
markets
Distant markets require extension
transportation system to obtain goods
3
Pages 171-176
Agriculture and the Environment
Hog Manure Spill, Clay Cty, KY
Above Ground Manure Pit
4
Manure Runoff and Soil Loss
Agriculture and the Environment
Global climate change
Impacts of changes in rainfall
patterns
Impacts of temperature changes
Other environmental impacts
Odor from CAFO (Concentrated
Animal Feeding Operations)
5
Pages 171-176
Agriculture and the Environment
6
Agriculture and the Environment
7
Economics of the Environment
 From 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?
8
Pages 177
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
9
Page 177
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?
10
Page 177
Economics of the Environment
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
WTP → Demand
curve for pollution
MC
abatement
C3
P1
Socially efficient
abatement level
P2
C2
C1
P3
11
WTP
A1 A2 A3
A4
At A4 too much
abatement, Why?
Pollution
Abatement (Reduction)
Page 177
Economics of the Environment
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
Page 177
Efficient Property Rights
Efficient property rights are characteristics
that ensure a socially optimal provision of
goods and services will be provided
Property rights: Privileges and limitations that
are associated with the ownership of a resource
Enforceability: Can enforce individual property
rights
Transferability: One is able to transfer property
rights from one individual to another
Exclusivity: All associated benefits and costs
are received by only one individual at a time
13
Pages 178-179
Efficient Property Rights
Enforceability: 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
14
Pages 178-179
Efficient Property Rights
Transferability: Property can be
transferred from one individual to
another
Example is laws prohibiting the sale of
certain goods
 Sale of goods made of ivory from endangered
species
No markets will arise because sale is not
allowed
Efficient transfer from one individual to
another cannot occur
15
Pages 178-179
Efficient Property Rights
Exclusivity: All associated benefits and
costs are received by only one
individual at a time
One example of this not existing when
some costs are not borne by the producer
of the good but by the public at large
16
Pages 178-179
Efficient Property Rights
Exclusivity: All associated benefits and
costs are received by only one
individual at a time
Example 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
17
Pages 178-179
Concept of Externality
Externality
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
18
Pages 178-179
Concept of Externality
Below represents aggregate market
demand and supply for good, Q
 Total willingness to
$
Sm=MCm
D
15
pay = A + B + C + D
 Producer surplus = B
 Consumer surplus = C
+D
 Total (societal) surplus
is B + C + D
C
Pm
B
6
19
Dm
A
Qm
Q
Page 179
Concept of Externality
Suppose 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
Page 179
Concept of Externality
The social marginal cost (MCS) is:
MCS = MCm + Ex
With Qm units produced there is additional cost
= Qm * Ex = area (B + C + E)
$
MCS = MCm + Ex
D
Sm = MCm
E
C
15
Pm
Ex = $9/unit of output
B
6
Dm
A
21
Qm
Q
Page 179
Concept of Externality
From the market equilibrium the social net benefits
(SNB) = CS + PS – External Costs
SNB = (B + C + D) – (B + C + E) = D – E
CS + PS
External Costs
$
MCS = MCm+Ex
D
15
Pm
Sm = MCm
E
C
Ex = $9/unit of output
B
6
Dm
A
Qm
Q
Page 179
Concept of Externality
 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**?
MCS = MCm+ Ex
D
E
15
F
Sm = MCm
Qm*→ SNB* = D – E –F – G
→ SNB* < SNB
Qm** → SNB** = D
→ SNB** > SNB
At Qm and Qm* production is
inefficiently high relative to
socially optimal, Qm**
G
6
Dm
Qm**
Qm Qm*
From above:
SNB = D - E
Q
Page 179
Concept of Externality
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?
$
MCS=MCm+Ex
At the market level of
production, Qm
Sm=MCm
 Consumers willing to pay Pm
 The cost to producers is Pm
 →the SNB for the mth (i.e.,
Pm
last) unit purchased is 0
 MCM =Pm
Dm
Qm
Q
Page 179
Concept of Externality
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?
$
MCS=MCm+Ex
Sm=MCm
E
Pm
 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
Dm
Qm
Q
Page 179
Concept of Externality
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
Page 179
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
Environmental Policies
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.”
Pages 180-183
Environmental Policies
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
29
Pages 180-183
Environmental Policies
Dairy farmer/Trout Unlimited example
MCS=MCm+Ex
$
C
A
Sm=MCm
D
B
Qm*
Qm
Q
 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 – C
Q* = A
Pages 180-183
Environmental Policies
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 Policies
Given 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
target
Command-and-Control policies
Taxes and subsidies
Transferable rights
Pages 180-183
Environmental Policies
Command and Control: Environmental
policy consisting of regulations on
technology or restrictions on practices
All economic agents treated equally
 All firms required to abate to the same level
 All must install same equipment
33
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 180-183
Environmental Policies
Example: Two farmers and a requirement
to reduce non-point pollution
Producer John uses older technology →
reducing pollution could be costly
Producer Sue uses newer technology →
reducing pollution achieved relatively cheaply
If 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
34
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Pages 180-183
Environmental Policies
$
A
B
$
$
C
MC1 $
MC1
D1
MC2
D2
MC2
0
5
10
A1
0
5
10
A2
0
A2
10
5
10
5
0
A1
Figures A & B represent the abatement MC
for Firms 1 and 2
MC ↑ with abatement level
Fig. C combines these two figures
35
D2 < D1 where each firm has 5 abatement Pages
units180-183
Environmental Policies
MC1 $
$
D1,4
MC2
D2,6
0
4 5
10
10
6 5
0
A2
Movement to the right (left)
would ↑ (↓) abatement for
Firm 1 and ↓ (↑) abatement of
Firm 2
Assume we want total
abatement to equal 10 units
A1
 Firm 1:
 Firm 1:
 Firm 1:
 Firm 1:
10 → Firm 2: 0
0 → Firm 2: 10
5 → Firm 2: 5
4 → Firm 2: 6
D1,4: MC of firm 1 for 4 units of abatement
D2,6: MC of firm 2 for 6 units of abatement
36
Pages 180-183
Environmental Policies
 If A1 = A2 = 5 units the total
abatement cost (TAC) is:
TAC = A + B + C
MC1
$
Firm 1 Firm 2
 Firm 1’s last unit of abatement
MC1*
MC2*
MC2
A
0
A2
10
cost much higher than the last
unit of Firm 2’s abatement
F
B
 Difference = MC1*- MC2*
C
 → that TAC could be reduced if
3
5
10
7
5
0
A1
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
Pages 180-183
Environmental Policies
MC1
$
MC1*
TAC=A+C+B
B
MC2*
MC2
A
A2
10
TAC*= D+E
MC*
MC2
C
5
0
MC1
$
5
D
10
0
A1
0
A2
10
E
5
10
5
0
A1
TAC reduced if Firm 2 abates more, Firm 1 less
 TAC is minimized when MC1 = MC2 (i.e., TAC*)
 TAC* = D + E
 TAC - TAC* = B = amount cost reduced for same total economy
abatement (10)
How do I know that A + C = D + E?
Each firm could be assigned firm-specific targets
38
 Would have to know the MC curves of each
firm© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
Pages 180-183
Environmental Policies
Taxes and Subsidies:
An incentivebased approach to environmental
policy
Subsidy: Promote abatement
Tax: 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 units
A1 < 3 → MC1 < S, A2 > 7 → MC2 > S
A1 > 3 → MC1 > S, A2 < 7 → MC2 < S
A1 = 3 & A2 = 7 → MC1 = MC2 = S
39
MC1
$
S
MC2
0
A2
10
3
5
10
7
5
0
A1
Pages 180-183
Environmental Policies
A tax on pollution would work just like a
subsidy on pollution abatement
A tax of $T per unit of pollution
→ each unit of abatement saves the firm $T
The firm will continue to abate as long as
the tax savings are ≥ MC of abating
One could also tax the output whose
production generates the pollution
 $T*/unit of output
Shifts up the firm’s (industry’s) marginal
cost curve
Pages 180-183
40
Environmental Policies
A tax on output (Pigovian Tax)would
shift up the marginal cost curve
$
Pm*
Price increase ≠ T*
Impact on producers vs.
MCS=MCm+ T*
T*
D
Sm
C
B
Pm
A
E
F
Dm
41
Qm*
Qm
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
consumers?
 PS ↓ from A+F to C
 CS ↓ from B+C+D+E to D
 Amount of tax collected = A
+B
Deadweight loss to society
of Pogovian tax = E+F
Tax collected = A + B
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Pages 180-183
Environmental Policies
Difficulty with Pigovian tax is setting
tax rate to counterbalance negative
externality effects
$T* = $Ex?
Tax revenue used to pay damages of the
externality
Lobbying of gov’t by polluters
↓ of tax rate
↓ mitigating effect of the tax
Sub-optimal solution from society’s
perspective
42
Introduction to Agricultural Economics, 5th ed
Penson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,
Upper Saddle River, NJ 07458. • All Rights Reserved.
Pages 180-183
Environmental Policies
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 achieved
T too low, too little abatement
T too high, too much abatement
43
Pages 180-183
Environmental Policies
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 polluters
Moves the permits to those polluters with
relatively high abatement costs
As long as aggregate pollution level stays below
the target, the gov’t does not worry who is
polluting
Pages 180-183
Environmental Policies
TDP Example: Firm 1
and Firm 2 are required to
do 5 units of abatement
MC1 > MC2 at this level
A trade could work out
where Firm 1 could pay
Firm 2 for a permit
Firm 1 ↑ pollution
Firm 2 ↓ pollution
MC1
$
MC2
0
5
10
10
5
0
A1
A2
Permits could continue
until MC1 = MC2
Pages 180-183
Environmental Policies
Advantage of a Transferable Rights
program:
Are cost effective given the least cost of TCP
could be achieved
Gov’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 Use
Farmer 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 Use
Soil 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?
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
Discounting and Present Value
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
Discounting and Present Value
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
Number of years
Initial deposit
Interest rate
 You would be indifferent between $8.04 5years 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
Discounting and Present Value
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
Discounting and Present Value
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
Discounting and Present Value
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:
V
Y1
1  ρ 
1

Y2
1  ρ 
PV of yr 1
PV of yr 2
income
income
2

Y3
1  ρ 
3

PV of yr 3
income
Pages 183-187
Discounting and Present Value
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:
*
Y
 V* 
ρ
 V* is referred to as the capitalized value of the
constant income stream, $Y* given interest rate ρ
Pages 183-187
Economics of Soil Use
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
Economics of Soil Use
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
Water as an Asset
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
We 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 are
such 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 Asset
One farmer is upstream of the other
 Will use 80 acre-feet of water
 → Only 20 acre-feet for downstream farmer
$
Downstream farmer
MR
20
Irrigation Marginal
Revenue and Marginal Cost
Both farmers have
the same revenue
and cost curves
Upstream farmer MR = Implied value of
one more unit of water
MC
MC = Cost of producing
one more unit of water
80
100
Pages 187-189
Water as an Asset
$
A
 The 80/20 allocation is
Downstream farmer
B
MR
Upstream farmer
C
D
20
MC
80
100
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
Water as an Asset
If 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 water
This result is due to the assumed cost and
revenue structures being the same across
farmers
Pages 187-189
Water as an Asset
Given the assumption of equal cost and
revenue structures for both farmers
Total 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
Summary
Economists 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…