Transcript Introduction to Production and Resource Use
Natural Resources, the Environment and Agriculture Chapter 10
2
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
3
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 Pages 171-176
Agriculture and the Environment
Hog Manure Spill, Clay Cty, KY Manure Runoff and Soil Loss
4
Above Ground Manure Pit
5
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) Pages 171-176
6
Agriculture and the Environment
7
Agriculture and the Environment
8
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?
Pages 177
9
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 177
10
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 177
11
C 3 P 1 P 2 $
Economics of the Environment
At A 1 , ↑ abatement (↓pollution) would cost C 1 but public would be willing to pay P 1
If WTP > MC then society’s net benefit will be increased by increasing abatement MC WTP → Demand curve for pollution abatement Socially efficient abatement level C 2 C 1 P 3 WTP At A 4 too much abatement, Why?
A 1 A 2 A 3 A 4 Pollution Abatement (Reduction) Page 177
12
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 Page 177
13
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 Pages 178-179
14
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 Pages 178-179
15
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 Pages 178-179
16
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 Pages 178-179
17
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 Pages 178-179
18
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 Pages 178-179
19
Concept of Externality
15 P m 6
Below represents
aggregate
market demand and supply for good, Q $ D B C A S m =MC m D m
Total willingness to
pay = A + B + C + D Producer surplus = B Consumer surplus = C
+ D Total (societal) surplus is B + C + D Q Q m Page 179
20
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 (E x ) are constant at $9/unit of Q
The social marginal cost (MC S ) per unit of production is: MC S = MC m + E x Page 179
21
Concept of Externality
The social marginal cost (MC S ) is: MC S
With Q m = MC m + E x units produced there is additional cost = Q m * E x = area ( B + C + E ) $ MC S = MC m + E x S m = MC m D E C 15 P m E x = $9/unit of output B 6 D m A Page 179 Q Q m
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
MC S = MC m +E x S m = MC m D E 15 P m C E x = $9/unit of output B 6 A D m Q Q m Page 179
Concept of Externality
How can we increase the SNB = (CS + PS – $ Externality)?
What happens if we increase production to Q m *?
What happens if we decrease production to Q m **?
MC S = MC m + E x From above:
SNB
= D - E S m = MC m D F E 15 6 G D m Q m *→ SNB* = D – E –F – G → SNB* <
SNB
Q m ** → SNB** = D → SNB** >
SNB
At Q m and Q m * production is inefficiently high relative to socially optimal, Q m ** Q Q m ** Q m Q m * Page 179
Concept of Externality
P m
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?
MC S =MC m +E x
At the
market level
of S m =MC m production, Q m
Consumers willing to pay P m
The cost to producers is P m
→the SNB for the m th (i.e.,
last
) unit purchased is 0
MC M =P m D m Q Q m 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?
$ MC S =MC m +E x P m E S m =MC m
There are additional social
costs (area E) →the marginal SNB for the last unit purchased is (WTP – MC m – E x ) where we assumed E x =$9 per unit of Q D m Q Q m 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, E x 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
29
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 Pages 180-183
Environmental Policies
$
Dairy farmer/Trout Unlimited example MC S =MC m +E x
Q m * is socially optimal pollution for farm
Area C is the externality A D C S m =MC m
(cost) of producing Q m Trout Unlimited offers a bribe of C + D to produce B Q m * Q m Q
Q m * PS w/o payment = A + B + D w/payment = A+B+C+D
Social Net benefits Q m = 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
33
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
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
34
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
Introduction to Agricultural Economics, 5 th ed
Penson, Capps, Rosson, and Woodward © 2010 Pearson Higher Education,
Pages 180-183
D 1 $ A
Environmental Policies
B $ $ C MC 1 MC 1 $ MC 2 D 2 MC 2
35
0 5 10 A 1 0 5 10 A 2 A 2 0 10 5 5 10 0
Figures A & B represent the abatement MC A 1 for Firms 1 and 2
MC ↑ with abatement level
Fig. C combines these two figures
D 2 < D 1 where each firm has 5 abatement units Pages 180-183
Environmental Policies
36
D 1,4 D 2,6 $ A 2 0 10 4 5 6 5 MC 1 $ MC 2 10 0
Movement to the right ( left ) would ↑ ( ↓ ) abatement for Firm 1 and ↓ ( ↑ ) abatement of A 1 Firm 2
Assume we want total abatement to equal 10 units
Firm 1: 10 → Firm 2: 0
Firm 1: 0 → Firm 2: 10
Firm 1: 5 → Firm 2: 5
Firm 1: 4 → Firm 2: 6 D 1,4 : MC of firm 1 for 4 units of abatement D 2,6 : MC of firm 2 for 6 units of abatement Pages 180-183
Environmental Policies
MC 1 * MC 2 * $ 0 A 2 10 3 7 A 5 5 C MC 1
If A 1 = A 2 = 5 units the
total abatement cost
(TAC) is: TAC = A + B + C 10 0 MC 2 A 1
Firm 1’s last unit of abatement cost much higher than the last unit of Firm 2’s abatement
Difference = MC 1 *- MC 2 *
→ that TAC could be reduced if Firm 2 abates more, Firm 1 less
TAC is minimized when MC 1 = MC 2
Firm 1 Firm 2 A 1 =3, A 2 =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
MC 1 $ MC 1 MC 1 * MC 2 * A B TAC=A+C+B MC 2 C MC* TAC*= D+E MC 2 E D 0 5 10 A 1 A 1 0 5 10 A 2 10 5 0 A 2 10 5 0
TAC reduced if Firm 2 abates more, Firm 1 less
TAC is minimized when MC 1 = MC 2 (i.e., TAC*)
TAC* = D + E
TAC - TAC* = B = amount cost reduced for same total economy
38
abatement (10)
Penson, Capps, Rosson, and Woodward
How do I know that A + C = D + E?
Each firm could be assigned firm-specific targets Would have to know the MC curves of each firm Pages 180-183
Environmental Policies
Taxes and Subsidies
: An incentive based approach to environmental policy
Subsidy: Promote abatement
Tax: Penalize for pollution
Assume we have a
subsidy
of S dollars on pollution abatement to
39
minimize TAC
Firm 1 will abate 3 units, Firm 2 will abate 7 units
A 1 < 3 → MC 1 < S, A 2 > 7 → MC 2 > S
A 1 > 3 → MC 1
A 1 = 3 & A 2 > S, A 2 = 7 → MC < 7 → MC 1 = MC 2 2 = S < S S $ 0 A 2 10 3 7 5 5 MC 1 10 0 MC 2 A 1 Pages 180-183
40
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
Environmental Policies
41
A tax on output (
Pigovian Tax
)would P m * P m shift up the marginal cost curve $ MC S =MC m + T*
Price increase ≠ T*
Impact on producers vs. D C B E T* S m consumers?
PS ↓ from A+F to C
CS ↓ from B+C+D+E to D
Amount of tax collected = A F A D m + B
Deadweight loss to society of Pogovian tax = E+F
Tax collected = A + B Q m * Q
th
m
ed
© 2010 Pearson Higher Education,
Pages 180-183
42
Environmental Policies
Difficulty with Pigovian tax is setting tax rate to counterbalance negative externality effects
$T* = $E x ?
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
Introduction to Agricultural Economics, 5 th ed
Penson, Capps, Rosson, and Woodward © 2010 Pearson Higher Education,
Pages 180-183
43
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 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 MC 1 > MC 2 at this level
A trade could work out where Firm 1 could pay Firm 2 for a permit
Firm 1 ↑ pollution
Firm 2 ↓ pollution
Permits could continue until MC 1 = MC 2 $ A 2 0 10 5 5 MC 1 MC 2 10 A 1 0 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?
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
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 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
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 Y t , the PV of the stream of income (V) is:
V Y 1 Y 2 Y 3 3
PV of yr 1 income PV of yr 2 income 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:
V * Y * 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 Irrigation Marginal Revenue and Marginal Cost 20 Both farmers have the same revenue and cost curves MR 80 Upstream farmer MC
MR
= Implied value of one more unit of water
MC
= Cost of producing one more unit of water 100 Pages 187-189
$ C A
Water as an Asset
Downstream farmer 20 B D MR Upstream farmer 80 100 MC
The 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
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