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Economic instruments to control water quality degradation in the Lower Mainland McAuley, Julie Anne 1994

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ECONOMIC INSTRUMENTS TO CONTROL WATER QUALITY DEGRADATIONIN THE LOWER MAINLANDbyJULIE ANNE MCAULEYB.Sc. (Agr.), University of British Columbia, 1992A THESIS SUBMITTED IN PARTIAL FULFILMENT OFTHE REQUIREMENTS FOR THE DEGREE OFMASTER OF SCIENCEinTHE FACULTY OF GRADUATE STUDIES(Department of Agricultural Economics)We accept this thesis as conformingto the required standardTHE UNIVERSITY OF BRITISH COLUMBIAAugust 1994Julie Anne McAuleyIn presenting this thesis in partial fulfilmentof the requirements for an advanceddegree at the University of British Columbia, Iagree that the Library shall make itfreely available for reference and study. I further agree that permission for extensivecopying of this thesis for scholarly purposesmay be granted by the head of mydepartment or by his or her representatives. It is understood that copying orpublication of this thesis for financial gain shall not be allowed without my writtenpermission.(S!gnature)__________________________Department of fi (UThe University of British ColumbiaVancouver, CanadaDate /0/ /4DE-6 (2)88)11ABSTRACTNitrate pollution of ground and surface water can stem from the mismanagement andover-application of both inorganic and organic fertilizers. This results in the occurrence ofnon-point externalities, which infringe on the overall level of social welfare.Market based environmental policies, known as economic instruments, can bedeveloped to curb the level of this non-point externality. Such policies directly affect themanagement decisions of agricultural producers, providing them with incentives to changetheir management practices. The overall objective of this study is to analyze an array ofeconomic instruments which could feasibly curb water quality degradation resulting from theover-application and misuse of manure and inorganic fertilizers in agricultural production.The economic instruments are compared in terms of their relative effectiveness in decreasingnitrate water pollution and social damage.This thesis develops a three agent manure market model, wherein a vegetable producerand composter can purchase manure from a dairy producer or inorganic fertilizer from anexogenous fertilizer market. The production activities of each agent are modelled using realworld production data. A non-linear programming technique is used.The imposition of a percentage manure tax was found to alter the vegetable producer’sderived demand for manure, and resulted in less manure being exchanged between the dairyand vegetable producers. The provisions of a percentage manure composting subsidyincreased the quantity of manure demanded by the composter and decreased the amount ofmanure consumed by the vegetable and dairy producers. The imposition of an inorganicfertilizer tax increased the demands for manure fertilizer, as did the manure application limit.111The effects on social damage are dependent on the leaching and surface run-offsusceptibilities of each operation’s associated land base.The composting subsidy appeared to be the most efficient instrument for decreasingthe overall level of social damage, when qualitatively analyzed. It induced decreases in thedemand for manure by both the dairy and vegetable producers, while increasing the demandfor manure of the composter. This results in an overall social benefit. There must be,however, financial justification for the implementation of such an instrument.ivTABLE OF CONTENTSpageABSTRACT.iiTABLE OF CONTENTS ivLIST OF FIGURES . viLIST OF TABLES viiACKNOWLEDGEMENTS viiiCHAPTER ONEINTRODUCTION 11.1 Background Information 11.2 Problem Statement 41.3 Study Objectives 71.4 Outline of Thesis 8CHAPTER TWOLITERATURE REVIEW 92.1 Theoretical Considerations 92.1.1 Neoclassical Considerations of Environmental Economics . . . 102.1.2 Public Goods and Property Rights 122.1.3 The Concept of Externalities 142.1.4 Market Failures and Alternative Approaches for Remedy 172.1.5 Economic Instruments versus Command and Control Policies 192.2 Specific Types of Economic Instruments 222.3 Economic Instruments in Practice 27CHAPTER THREEMETHODOLOGY 323.1 Conceptual Model 323.1.1 Overall Model Description 323.1.2 Base Case Model Description 343.1.3 Vegetable Manure Tax 363.1.4 Composting Subsidy 383.1.5 Quantitative Manure Application Limit 393.2 Mathematical Specification of the Model - Without EconomicInstruments 463.2.1 Dairy Producer 473.2.2 Vegetable Producer 523.2.3 Composter or Alternative Nitrogen Converter .. 54V3.3.1 Manure Tax3.3.23.3.33.3.43.3.5CHAPTER FOURDATA4.1 Dairy Producer4.2 Vegetable Producer4.3 Composter4.4 Model Calibrationpage5556565859616263CHAPTER FWEEMPIRICAL RESULTS5.1 Empirical Results from Base Case Model5.2 Empirical Results from the Manure Tax Model5.3 Empirical Results from Inorganic Tax Model5.4 Empirical Results from the Subsidy Model5.5 Empirical Results from Quantitative Manure Application LimitModel5.6 Empirical Results from Combined Manure Tax and CompostingSubsidyAPPENDIX 5AAPPENDIX 5BAPPENDIX SCAPPENDIX 5DAPPENDIX 5ECHAPTER SIXSUMMARY and CONCLUSIONS6.1 Methodology6.2 Summary of Results6.3 Conclusions and Further Research3.2.4 Combined Market Model3.2.5 Solution Procedure3.3 Economic Instruments Model DescriptionInorganic Nitrogen TaxComposting SubsidyQuantitative RestrictionsSummary65656974757777808488919496101104108110113113114117REFERENCES 119viLIST OF FIGURESpageFIGURE ONE 41FIGURE TWO 42FIGURE THREE 43FIGURE FOUR 44FIGURE FIVE 45viiLIST OF TABLESpageTable 4.1 Input Requirements and Yields of Winter Wheat and Corn CroppingSystems 66Table 4.2 Dairy Feed Production Function Parameters 67Table 4.3 Additional Parameters of the Dairy Producer’s Objective Function 69Table 4.4 Vegetable Production Function Parameters 71Table 4.5 Additional Parameters of the Vegetable Producer’s ObjectiveFunction 72Table 5.1 Summary of Base Case Model Simulation 78Table 5.2 Summary of Variables Under Manure Tax Scenario 81Table 5.3 Summary of Variables Under Inorganic Fertilizer Tax Scenario 85Table 5.4 Summary of Variables Under The Composting Subsidy Scenario 89Table 5.5 Summary of Variables Under Manure Application Limit (DM = 51000) 92Table 5A. 1 Summary of Variables Under Manure Tax Scenario (tax = 0.25) 96Table 5A.2 Summary of Variables Under Manure Tax Scenario (tax = 0.45) 97Table 5A.3 Summary of Variables Under Manure Tax Scenario (tax = 0.55) 98Table 5A.4 Summary of Variables Under Manure Tax Scenario (tax = 0.7) 99Table 5A.5 Summary of Variables Under Manure Tax Scenario (tax = 0.9) 100Table 5B. 1 Summary of Variables with Inorganic Fertilizer Tax Scenario(inotax=0.1) 101Table 5B.2 Summary of Variables with Inorganic Fertilizer Tax Scenario(inotax = 0.2) 102Table 5B.3 Summary of Variables with Inorganic Fertilizer Tax Scenario(inotax = 0.3) 103Table SC. 1 Summary of Variables Under Composting Subsidy (S=0.25) 104Table 5C.2 Summary of Variables Under Composting Subsidy (S=0.5) 105Table 5C.3 Summary of Variables Under Composting Subsidy (S=0.7) 106Table 5C.4 Summary of Variables Under Composting Subsidy (S=0.9) 107Table SD. 1 Summary of Variables Under Manure Application Limit(DM=40000) 108Table 5D.2 Summary of Variables Under Manure Application Limit(DM= 30000) 109Table 5E. 1 Summary of Variables Under Combined Manure Tax andComposting Subsidy Scenario #1 110Table 5E.2 Summary of Variables Under Combined Manure Tax andComposting Subsidy Scenario #2 111Table 5E.3 Summary of Variables Under Combined Manure Tax andComposting Subsidy Scenario #3 112viiiACKNOWLEDGEMENTSI would like to thank the members of my thesis committee: Dr. James Vercammen,Dr. Rick Barichello, and Dr. Casey van Kooten. Thanks especially to Jim, my principaladvisor, for his generous support and contributions to this thesis. Thanks also to RogerMcNiell and Environment Canada, which provided funding for this thesis.Thanks is given to Kathy Shynkaryk and Retha Gertsmar for their support, help andencouragement throughout the completion of this thesis. I would like to my colleagues inthe Department of Agricultural Economics, in particular Laura Cain, without whom the lastfive years would have been extremely calm and boring.Most of all, I would like to thank my family, whose support and encouragementthroughout my schooling has been greatly appreciated. They finally have the answer to theirnever-ending question: Is your thesis finished yet?!1CHAPTER ONEINTRODUCTION1.1 Background Information“Of all of the activities of man that influence the quality of ground water, agricultureis probably the most important, as a diffuse source of pollution from fertilizers, pesticides,and animal wastes” (Sanderson, 1981, p.18). Over the past decade, the impact of ouragricultural activities on land and water quality has come with percievedly highenvironmental costs. The focus of these activities on productivity has, in most cases,unintentionally left our water resources open to degradation and contamination. This isunintentional as our agricultural system is “maintained by a highly complex system of farmimplement and agrochemical industries, a highly developed marketing [structure], andgovernment institutions” (Norgaard 1984, p.162).Environmental costs can be referred to as externalities. “An externality existswhenever the welfare of some agent, either a firm or household, depends directly, not onlyon his or her activities, but also on activities under the control of other agents as well”(Tietenberg, 1988, p.4.5). Externalities typically stem from producers responding to privateincentives rather than public or social desires. For example, a dairy producer faces theprivate incentive of increased revenues when he/she stores and sells manure to otherproducers. These activities are undertaken without regard for the potential effects on socialdamage that nitrate leaching and surface manure run-off can have.2Environmental externalities stemming from agriculture are typically ‘non-point’ innature. “A non-point externality exists whenever the externality contributions of individualeconomic agents cannot be practically measured by direct monitoring” (Griffin and Bromley,1982, p.547). Non-point agricultural sources of water-based nitrogen result primarily fromorganic and inorganic materials being added to, or placed on, soils for crop nutrition ormanure disposal. Nitrates, the converted plant-usable form of nitrogen, are soluble and moveeasily through soil (Sanderson, 1981). Consequently, movement of these materials has beentraced from their soil origin to surface and ground water supplies. Both surface and groundwater pollution, through run-off and leaching of manures and inorganic fertilizers, areproblems of increasing importance, particularly in the Lower Fraser Valley of BritishColumbia. This area contains the Abbotsford aquifer -- a confined aquifer which provideswater to the surrounding community.Canadian regulations, as defined in Health and Welfare Canada’s Canadian DrinkingWater Ouality Guidelines, permit the maximum acceptable concentrations of 10 mg/L ofnitrate in drinicing water. “Although nitrate itself is relatively nontoxic, it is reduced byintestinal bacteria into nitrite, a hazardous substance. In addition, long exposure to nitrateis a suspected cause of cancer” (Edwards, 1988, pp.4.’75,4.76). Infants, who are exposed tohigher nitrate concentrations, may develop methaemoglobinaemia (more commonly referredto as blue baby syndrome) as a result of this nitrate to nitrite conversion. Although thisdisease has only been linked to water nitrate concentrations in excess of 45 mg/L, theFederal-Provincial Working Group on Drinking Water established a water nitrateconcentration objective of 0.00 1 mg/L in 1978.3In 1982, nitrate concentrations in 23 of 24 wells tested in the south west corner of theAbbotsford aquifer exceeded the 10 mg/L nitrate concentration limit. Kwong (1986) found,through a data review and field sampling study in the South Matsqui and South Abbotsfordareas, that much of the ground water in the area was contaminated with nitrates.Environment Canada (1989) found that, in the same general area, 46 out of 73 sample siteshad nitrate concentrations exceeding 10 mg/L.Liebscher, Hii and McNaughton (1992), reported that nitrate concentrations in theAbbotsford aquifer area appear to be increasing, and on average, are greater than 10 mg/L.This stems mainly from the ongoing mismanagement of manure and inorganic fertilizers, bycarelessly discarding excess manure-fertilizer mixes onto the land, or storing them in leakycontainers. Theoretically, the maximum amount of nitrogen applied to land should notexceed the amount that is required by the crop. Unfortunately, it is difficult to determine theexact quantity of nitrogen required by crops. Soil types vary in their absorption capabilities,resulting in differing levels of nitrate percolation between separate soil regions. Hence, theresulting environmental effects differ from site to site. By applying manure and fertilizersat certain times of the year, the farmer can reduce the amount of nitrate that enters the watersupply. Therefore, comprehensive regulations need to be implemented which could reducethe overall use of nitrogen inputs in agricultural systems, and alter the production decisionsof producers. In this way, the occurrence of the nitrate pollution externality can be decreased,and social welfare can increase. Without such measures, there may be continuedcontamination of water resources.41.2 Problem StatementCurrent manure management guidelines for British Columbia, established in April1992, are found in the British Columbia Waste Management Act, which includes The Codeof Agricultural Practice for Waste Management. This code recommends practices for thestorage and spreading of animal wastes and the proximity of livestock operations towaterways. Under the Act, the application of manure to fields for crop growth is deemed anacceptable practice. Applications, however, for non-crop use are considered pollution and aresubject to penalties, and possible court action under the Waste Management Act (B.C., 1992).Unfortunately this Act and Code may not be sufficient in dealing with the serious waterquality problems that exist in British Columbia (particularly in the Fraser Valley). There is,in practice, difficulty in determining the nitrogen and manure requirements of crops duringtheir growth periods, resulting in the over-application of manure. Furthermore, the Act andCode do not address the use of inorganic fertilizers, and the excess nitrogen which may resultfrom their misuse and over-application.Some provinces have released mandates aimed at taking tough action against waterpollution due to poor manure management. In Quebec, “fines of up to $100,000 and possibleimprisonment are in store for direct discharge of solid and liquid manure, spreading duringprohibited periods (October 1 - April 1), or other such acts” (Palmer-Benson, 1990, p.17).Monitoring of farm activities is carried out by aerial surveillance, permits are required for theexpansion of any livestock operation, and producers must prove that they have sufficient landon which to spread manure. Legislation has also been introduced to force producers withliquid manure to build leak-proof pits or containers, where no leakage would occur over a5200 day period. Those with manure storage facilities posing a threat to the environment aretold to clean up their operations or face closure.These policies, while effective to some degree, do not address the fundamental issuesof there being too much nitrate present in the ground and surface water. They neither addressthe redistribution of organic fertilizers to other areas and regions where leaching and run-offare less prevalent, nor the application of inorganic fertilizers. The principal approach toreducing water pollution externalities in agriculture, such as those described above, has beenmoral suasion supplemented, to varying degrees, by technical and financial assistance. Thelimited results from this approach, along with the growing demand for water qualityprotection, has created a substantial interest in the implementation of more effective policyinstruments” (Shortle and Laughiand, 1994, p.3). Such initiatives include “rethinking policiesaimed at reducing input sources such as herbicides and fertilizers” (Archer and Shogren,1994, p.38).Economic instruments may be implemented to meet environmental goals. They are“instruments that affect costs and benefits of alternative actions open to economic agents,with the effect of influencing behaviour in a way that is favourable to the environment”(OECD, 1991, p.10). For example, market prices for fertilizers (be they inorganic or organic)are not reflective of the actual changes in water quality, and hence social damage, which mayresult from their misuse and over-application. With the inclusion of a price-based economicinstrument, such as a tax, the market prices of these substances become more reflective ofthe potential social effects associated with their use. Hence, the original market price isrendered ineffective while the altered market price (altered by the implementation of an6economic instrument) becomes more representative of the desired socially efficient marketoutcome.Typically, the implementation of economic instruments involves a monetary transferbetween those individuals who cause pollution and the community, although, in someinstances, new markets can be created. Economic instruments both substitute or complementpre-existing environmental policies to directly attain environmental goals. The use of directenvironmental regulation within the agricultural industry, excluding comprehensive bansagainst certain substances such as ALAR pesticide, may be virtually impossible to implement.Economic instruments on the other hand, can be more easily established and are moreappropriate to a number of the environmental problems encountered in today’s modernagricultural industry. Taxes, subsidies, marketable emissions permits, quantitative limits andeffluent charges are all forms of economic instruments.The occurrence of negative environmental externalities, such as nitrate pollution ofwater, effects societal welfare. Such pollution, as mentioned, tends to be increasing in thelower Fraser Valley of British Columbia. While the above described forms of penalizationand direct regulation, as employed in British Columbia and Quebec respectively, may bemarginally effective in dealing with manure handling problems, they lack in practicality dueto the non-point nature of this pollution source. Hence, governmental focus has shifted tothe development of regulations which incorporate economic instruments.71.3 Study ObjectivesThe overall objective of this study is to apply and analyze an array of economicinstruments which could feasibly curb water quality degradation resulting from the over-application and misuse of manure and inorganic fertilizers in agricultural production. Theeconomic instruments are compared in terms of their relative effectiveness in decreasingnitrate water pollution. The advantages and disadvantages of each are discussed.The specific objectives of this thesis are:1) to develop a conceptual general equilibrium framework wherein markets forinorganic and organic fertilizers are created;2) to specify a mathematical model consistent with this conceptual framework;3) to calibrate this model using parameters and variables estimated from availableproduction and market data;4) to solve the model for a base case scenario, in which no economic instrumentsare present; and5) to trace through the effects of imposing various instruments into themanagement decisions of producers with the aim of altering their fertilizerconsumption and production behaviour.The economic instruments analyzed in this thesis are: manure taxes, inorganic fertilizer taxes,composting subsidies, manure application limits, and manure tax/composting subsidycombinations.81.4 Outline of ThesisThe following chapter will serve to analyze the appropriate literature surrounding thetheory of economic instruments and their potential applicability to environmental problems.The relevance is to highlight the economic theories surrounding the problem of agriculturalnon-point pollution of surface and ground water. In Chapter 3, a model is developed whichincorporates three economic agents and is intended to serve as a base case for the adoptionof economic instruments. Different economic instruments are incorporated into the model,each of which impinges upon the welfare of both producers and taxpayers and results indifferent level of social damage. Chapter 4 discusses data availability and limitations whileChapter 5 summarizes the results of the developed methodology, and compares them to theresults of similar studies. In Chapter 6, conclusions, limitations and further implications ofthis study’s findings are presented.9CHAPTER TWOLITERATURE REVIEWThe purpose of this chapter is to provide both theoretical and practical informationsurrounding the doctrine of environmental economics and the use of economic instrumentsin remedying market failures and externality situations. Section 2.1 provides a discussion ofthe theoretical motivations for using economic instruments. Section 2.2 reviews the generalnature of specific instruments, while section 2.3 reviews those instruments that have beenapplied to situations where water quality degradation has been encountered.2.1 Theoretical ConsiderationsEnvironmental economics is a vast field, containing numerous different theories. Thepurpose of this section is to present the theoretical motivations for using economicinstruments, including discussions of the concepts of public goods and property rights,externalities, and market failures. Each of the included sub-sections helps to outline the modeof nitrate water pollution analysis used in this thesis. The association between ground andsurface water resources, the theory of public goods and the absence of fully defmed propertyrights leads to the occurrence of externalities. In the presence of externalities such as nitratepollution from agricultural activities, market mechanisms fail, resulting in the need forcorrective policies. These market correcting policies can either be self-corrective, aspresented and discussed by Coase, or interventionist, as presented and discussed by Pigou.The advancement of interventionist policies has lead to the concept of economic instruments.10Section 2.1.1 outlines the neoclassical considerations which surround the field ofenvironmental economics. Section 2.1.2 discusses the theory of public goods and propertyrights. Section 2.1.3 summarizes the concept of externalities, while section 2.1.4 discussesthe concept of market failures and alternative approaches for the remedy. Finally, section2.1.5 compares the use of economic instruments versus command and control types ofintervention.2.1.1 Neoclassical Considerations of Environmental Economics“Economics is the science of allocating scarce resources among competing ends”(Dorfman, 1993, p.80); the analysis of economics, both at the micro and macro levels, isthrough markets. An economy has the overall task of producing “the combinations of goodsand services that will promote the welfare of the members of the community as much aspossible with the resources and production techniques available” (Dorfman, 1993, p.87). Thisresults in a certain level of welfare (or utility) for the individuals of a community. Theseutilities depend primarily on the individual’s consumption of goods and services, and his/herenvironmental conditions.The production and consumption of goods and services creates markets; it is througha combination of these markets and individual preferences and utilities that individuals andfirms make decisions. At a macro-level, these decisions are aggregated, allowing the marketto reflect the decisions and preferences of the economy as a whole. At a micro-level, marketsreflect individual, unaggregated preferences. Through the invisible hand of competition, aconcept developed by Adam Smith, a self-regulating economic system ofmarkets can develop11wherein firms and individuals strive to meet their pre-determined objectives (e.g., maximizingprofits, maximizing welfare and utility, and minimizing costs). This is done through thepurchase of goods and services to be used either for consumption by individuals, or as inputsin the production of other goods. The invisible hand, and the ensuing competition, guidesresources towards the production or consumption process where they will satisfy morecompletely the wants and needs of consumers. The invisible hand does not work, however,in situations where resources are not privately owned, as basic economic institutions are notavailable to provide individuals with incentives to use such resources efficiently (Dorfman,1993). For example, ground and surface water are not privately owned, hence they tend tobe misused. Pollution of ground and surface water from agricultural activities occurs asframeworks, such as the invisible hand, are either unavailable or unable to function, resultingin the inefficient use of the water resources in production activities. It is through this typeinefficiency in competition that externalities can arise and environment degradation can occur(Jacobs, 1991).Environmental economics stems from the overall concept of ‘neoclassical’ economics,where markets provide the basis for economic analysis. Essentially, environmental economicsallows for ‘markets’ to be created, hypothetically, for environmental goods and services,which are then valued by individuals in society. Since the environment is an unpriced publicgood, owned by all individuals, environmental commodities, such as water and soil, tend tobe overused and abused by the global population. Because there are no real prices,“environmental markets ... do not fully express individuals’ preferences for the environment”(Jacobs, 1991, p.xv), nor the relative scarcity of the resources. One such ‘market’ is for clean12surface and ground water. However, due to the inadequate specification of ownership, therelative scarcity of clean water cannot be interpreted. As market incentives are not presentto alter agricultural production behaviour, water polluting activities continue.The economic theory of environmental economics rests on three concepts. The firstis the concept of public goods, which are also known as common property resources orcollective goods; the others are the notion of externalities and market failures.2.1.2 Public Goods and Property RightsPublic goods can be classified as either pure or congestible. A pure public goodoccurs when the use of the good by one individual neither interferes with nor decreases thegood’s usefulness to other individuals. A scenic vista is a pure public good. The termcongestible public goods classifies those goods where their use by one individual does affectits usefulness to others. Ground and surface water are examples of congestible public goods.If water is polluted as a result of agricultural activities, individuals external to the productionprocesses are affected, through decreased recreational potential and decreased drinking waterquality.The notion of public goods is related to that of property rights. Property rights defmethe right to use a resource. Both types of public goods are unpriced and have communalproperty rights, meaning the good is shared by everyone. As the access to goods, such asground and surface water, cannot be controlled due to their natural occurrence, decisionscannot be made as to the amount of the public good which would be provided and used in13order to meet a social optimum. Therefore, society is left to decide the extent of use of thegoods.Ground and surface water are commonly used in agricultural and other production andconsumption processes. As with other inputs, such as labour and capital, their relativescarcity impinges on economic agents’ allocation and production decisions, with fullknowledge of forgone opportunities and costs. But, in the case of such naturally occurringpublic resources, the inherent yet unmeasurable concern over natural resource scarcity pushespeople and firms to make decisions of input allocation, without regard to the opportunitycosts to society and future generations of doing so. Each individual agent compares thebenefits and costs of using ground or surface water resources in production. The aggregationof these input demands activates the overall allocation of these public goods into differentproduction activities. Since the property rights associated with water are inadequatelyspecified, markets and prices that emerge from this type of collective economic action provideindividuals with the opportunity to over-exploit the resource. The result is a market failureas socially optimal levels of resources are no longer provided.When analysing nitrate water pollution problems, as with any environmental pollutionproblems, it is important that the costs and benefits of the polluting activity be fullyconsidered. The identification of the private and social costs and benefits associated withwater pollution helps promote the efficiency of the competitive output markets (Ruff, 1970).Once these are identified welfare evaluations can take place.142.1.3 The Concept of ExternalitiesTo economists, environmental degradation is a problem wherein “economic agentsimpose external costs upon society at large in the form of pollution. With no ‘prices’ toprovide the proper incentives for the reduction of polluting activities, the inevitable result [is]excessive demands on the assimilative capacity of the environment” (Baumol and Oates,1988, p.1). These external costs, or externalities, are a direct consequence of the environmentbeing a pure public good which cannot be divided up or formally owned by one individualand the absence of fully defined property rights. Hence, the polluting activities of oneindividual directly affect the activities of all other individuals in society. In addition theundepletable nature of public goods means that the increased consumption of the public goodby one individual does not reduce their availability to others (Baumol and Oates, 1988).The theory of externalities is based on the concept that each user of the public good,such as water, imposes a cost (benefit), either tangible, through inconvenience (convenience)or reduced (increased) productivity, or non-detectable. Since those wishing access toenvironmental resources are not charged a price, there is no means of detecting how muchusers are willing to pay to use the resources or how much their use will inconvenience othermembers of society (Dorfman, 1993). “An externality is usually defined as a situation inwhich the utility of an affected party is influenced by a vector of activities under his controlbut is affected by one or more activities under the control of another (or others)” (Randall,1981, p.151).There are two forms of externalities. A public externality is essentially undepletable,and relates mainly to resources to which access is non-discriminatory. Examples include15polluted air and water, and noise. A private externality is of a depletable form, and dealswith privately owned resources. There are very few convincing examples of depletableexternalities (Baumol and Oates, 1988). Externalities can be either positive or negative,depending on whether the activity undertaken generates an external cost or benefit. Anyactivity “which generates a positive level of welfare for a third party” (Pearce and Turner,1990, p.61), is a positive externality, or an external economy, whereas one which results ina loss of welfare is known as a negative externality, or an external diseconomy. A negativeexternality exists whenever an activity by one agent causes a loss of welfare to another agentand the loss of welfare is uncompensated (Pearce and Turner, 1990).Water pollution stemming from agricultural activities is an example of a negativeexternality. The difficulty arises here as property rights to ground and surface water have notbeen assigned. Hence, externalities stemming from agricultural activities which pollute thewater caimot be removed or effectively eliminated without the use of other economicinstruments and mechanisms. It is through these market mechanisms and policies thatenvironmental commodities can be used according to their value. Without such mechanisms,market failures prevail, and socially optimal levels of water and resource use cannot beattained.The production of any good which results in environmental pollution requireseconomic agents to face both costs from undertaking the production, and benefits or revenue,from the sale of the product. The difference between these costs and benefits is known asthe private net benefit. Accordingly, the marginal net private benefit (MNPB) is the benefitfrom expanding production by one unit. The marginal external cost (MEC) or marginal16damage function (MDF) is the value of additional damage caused by one unit of pollutionfrom producing more output, and occurs only if one or more individual suffers a loss inwelfare. The total social damage function shows how much damage is associated with eachlevel of pollution, and is translated into monetary terms. “In a multi-input framework, socialdamages depend upon total effluent” (Spulber, 1985, p.103). The MNPB is decreasing inoutput, while the MEC is increasing in output. When MEC exceeds the MNPB, societalwelfare is diminished, and society is worse off. Theoretically, society’s welfare is highestwhere MEC and MNPB are equal. This is not necessarily at the zero pollution level.The identification of these costs and benefits are difficult when dealing with nitratepollution. This type of pollution is non-point in nature; hence the level of pollution activityof each individual economic agent is immeasurable. This causes difficulty when ascertainingthe costs, benefits and damages associated with agricultural production. If an agriculturalproducer pollutes water (ground and or surface) and either incurs no costs associated withpolluting, or the pollution does not noticeably affect anyone else, then both the private andsocial costs of disposal are zero. Hence, the producer’s private decisions are sociallyefficient. However, “if these wastes do affect others, then the social costs of waste disposalare not zero. Private and social costs diverge, and private profit maximization decisions arenot socially efficient. It is this divergence between private and social costs that is thefundamental cause of pollution of all types” (Ruff, 1970, p.23). The pollution of water fromnitrates used in agricultural activities does affect others, hence the social costs of wastedisposal are not zero. However, the difficulty lies in identifying who caused the pollution.172.1.4 Market Failures and Alternative Approaches for RemedyThe central issue of environmental economics deals with reducing market failures, orexternal diseconomies. In theory, we know that when externalities are present, “the sociallyoptimal level of economic activity does not coincide with the private optimum” (Pearce andTurner, 1990, p.70). In other words, there is a divergence between the private and socialcosts and benefits of using the resource or public good (MNPB does not equal MEC)(Turvey, 1963). As a result, institutions, activities, and economic thought were developed andmethodologies evolved such that, under certain conditions, resource and environmental usecould be construed as efficient. This development is still being undertaken to answer thequestion of how to reach the social optimum. Different schools of thought on this issueinclude those of Coase, Pigou and ‘command and control’ types of intervention.Coase’s TheoryAccording to Coase (1960), if the market did not assure the optimal amount of theexternality present, bargaining, and potential compensation, could take place between thepolluter and sufferer (which is, in most cases, society), according to who held the propertyrights to the resource. This bargaining would result in an automatic tendency to approachtoward a socially optimum level of externality. “If the polluter had the right, the sufferer can‘compensate’ him not to pollute; if the sufferer has the right, the polluter can ‘compensate’him to tolerate the damage” (Pearce and Turner, 1990, p.17). These compensations wouldresults in transaction costs. According to this theory, government intervention would nolonger be needed to correct the externality, as the market would remedy the situation itself.18“In the absence of transactions costs, and where a system or property rights exists, allexternalities will be internalized through negotiations” (Homer, 1975, p.34.). An practicalapplication of Coase’s theory can be found when water pollution from a farmer’s field affectsthe welfare of the surrounding resident. The residents may offer the farmer side paymentsin the hopes of increasing their welfare and reducing the water pollution levels. This is,however, quite unlikely.Under certain situations, Coase’s theory does not hold and a social optimum cannotbe reached, such as in cases of imperfect competition and high transactions costs. The theorymay not hold when one cannot make definitive distinctions between individuals needing toparticipate in the bargaining process and those who would not. Coase’s solution toenvironmental pollution introduces the potential for individuals to enter into threat-making,an irrational use of scarce economic resources (Pearce and Turner, 1990; Coase, 1960). Asa result of the aforementioned, economists and policy makers have tended to assesenvironmental problems according to Pigou’s theories.Pigou’s TheoryAs a result of the publication of Pigou’s Economics of Welfare (1932), the mostfrequently suggested means of dealing with external diseconomies is through internalization.Through the imposition of a tax on the production of negative externalities, and a subsidy onthe production of positive externalities, market failures resulting from polluting activities canbe corrected (Dietz and van der Straaten, 1992). Pigou recognized that external effects werea cause of non-optimal efficiency levels in the economy. He theorized that by imposing19corrective price incentives, market prices would change, the MNPB and MEC could beequalized, the market inefficiency could decrease, and the socially optimal level of pollutionattained (Pearce and Turner, 1990). Such policies “eliminated the need to consider thetransactions costs preventing negotiations and ambiguity of property rights associated withnatural resources such as air and water” (Homer, 1975, p.34.). Pigou’s theory was suggestiveof strong public involvement.2.1.5 Economic Instruments versus Command and Control PoliciesThe Pigouvian method of externality internalization has been expanded to includenumerous types of economic instruments. While most economists advocate the use of priceincentives to induce an optimal externality situation, many politicians, in the past, felt thatchanges in environmental quality would be less predictable with economic instruments thanunder direct, or ‘command and control’, regulation (Dietz and van der Straaten, 1992). “Theuniformly applied practice of ‘command and control’ regulations mandates specific standardsfor emissions, or precise abatement technologies for all dischargers” (Dorfman, 1993, p.199).In agriculture, as in numerous other industries where environmental externalities arefound, the role of direct regulation, through rigid standards, has not always met the desiredoutcome of increased environmental quality. The inflexibility of direct regulation has resultedin the newly found belief of governments “that economic instruments can be an effectivecomplement to, and in some cases a substitute for, direct environmental regulations”(Government of Canada, Ministry of Supply and Services, 1990, p.10). Economicinstruments increase economic flexibility because “markets are much better than individuals20at processing a multiplicity of information and result in a better allocation of resources andestablishment of trade-offs between different goods and services” (OECD, 1991, p.13). Undercommand and control type systems, individuals are left both to interpret and to act on theenvironmental policy, and often face the affiliated costs of such policies individually.Producers, whose production decisions are more multi-faceted than profit driven alone,benefit from neoclassical measures such as price instruments. With such measures, they cangauge both the economic gains and losses associated with incorporating environmental costsdirectly into their decision making (Carriker, 1993). These environmental costs are openlyreflected through the inclusion of economic instruments (taxes, etc..) into producers’ objectivefunctions and constraints. They also identify the level of environmental damage associatedwith a particular pollutant or polluting activity. By implicit recognition of a continuousdamage function, overall environmental damage can be minimized and producers can adjusttheir production decisions, such as input mix, to reflect external costs (McGartland and Oates,1985).The effects of such price incentives can be interpreted using the neoclassical economicconcept of ‘marginal analysis’. The standard economic optimization problem involvesmaximization of the net gains, or the difference between private and social costs and benefits(MEC and MNPB), accrued from an undertaken activity. Included in these costs arepollution externalities and their effects on society. An optimal point is reached where themarginal cost and the marginal benefit from expanding the activity are equal (MEC=MNPB),and the net gain is maximized (Ruff, 1970). By incorporating environmentally-basedeconomic instruments into the optimization decisions of producers, small or incremental21changes in the levels of choice variables may result. Marginal analysis can be used toexamine the individual and societal welfare changes resulting from different policies. At themargin, individuals make trade-offs, or decisions, to increase their overall utility levels. Byusing economic instruments, which are more perceptible than command and control policies,rational economic agents can better comprehend these trade-offs.Various scholars support different forms of economic incentives for allocating optimallevels of externalities and pollution. For example, Pigou (1932) felt that the efficientallocation of a public good could be achieved through the appropriate application of taxes forthe use of that public good. On the other hand, Kneese (1964) emphasized the use ofdischarge fees to control pollution. Overall, economic instruments help to offer “savings inpollution abatement costs and improved environmental quality relative to a direct commandand control (or strict uniform regulation) outcome” (McGartland and Oates, 1985, p.2O’7).By establishing a system of regulatory economic incentives, producers will be provided with“the appropriate tools to internalize externalities and modify the profit maximizationdecisions” (Carriker, 1993, p.5).Agricultural activities impinge upon environmental quality both positively, throughincreased aesthetic appeal, and negatively, through water and soil quality deterioration. Sinceboth external economies and diseconomies exist, there are several mechanisms by whicheconomic instruments can be incorporated directly into agricultural production decisions.These economic instruments cannot focus solely on pollution control measures like charges,but must also incorporate on positive incentives such as subsidies (OECD, 1991). Thefollowing section describes a few of the applicable instruments in detail.222.2 Specific Types of Economic InstrumentsThe Pigouvian theory of internalization includes instruments which can be used toconstrain and alter economic activities so as to meet environmental targets. Governmentexpenditures and financial incentives are the types of pollution control incentives commonlyreferred to as economic instruments (Dietz and van der Straaten, 1992). Governmentexpenditures can be either actions taken directly by governments or subsidies or grantsprovided by governments to private organizations and households. Subsidies are consideredfinancial incentives, and consist of many different forms, including resource managementsubsidies, pollution abatement subsidies, and ‘good agricultural practices’ subsidies. Financialincentives, or market mechanisms, are designed to make environmentally damaging activitiesmore expensive, hence rendering them less attractive. Essentially, they involve theinternalization of externalities causing environmental damage by forcing polluters to pay thefull price of the environmental damage. They are identified with assigning environmentalgoods monetary values. There are essentially four types of financial incentives, the mostfrequently applied of which are charges, taxes, and subsidies.Taxes or charges discourage unwanted environmentally damaging behaviour bymaking it more expensive, and help provide revenue for the government. Through the directimplementation of a charge or tax, producers face revenue gains incentives to alter pollutingbehaviour. Taxes can be set such that economic efficiency can be improved through theinternalization of the pollution costs to the firm, requiring the polluting individual or firm toreduce the level of pollution.23If the polluting activity were to be taxed based upon the estimated damage done, themarginal private benefit would decrease by the amount of the tax. The polluter would thenbe faced with maximizing the MNPB subject to the tax. An optimal Pigouvian tax equalsthe marginal external cost (i.e, the marginal pollution damage function) at the optimalpollution level (Pearce and Turner, 1990). If the optimal value of the tax turns out to benegative, the victim of the externality is compensated (Baumol and Oates, 1988). It isimportant that the level of tax chosen sustains the competitive efficient equilibrium.There are some difficulties encountered in both setting and maintaining taxes at theright level and the handling of the revenue gained. Bauniol and Oates (1988) concluded thatuin the presence of an externality, optimal resource allocation calls for pricing that involveszero taxation and zero compensation to those affected by externalities (but non-zero taxationof their generators)” (Baumol and Oates, 1988, p.56). While the imposition of a tax orcharge may be politically feasible at first, its continual readjustment may not. The revenuesreceived from such environmental taxes should be earmarked for environmental purposes.Public policy aimed at reducing effluent can sometimes be directed towards reducingthe effluent generating activity by imposing a fmal output tax on the polluting firm (Spulber,1985). Although this approach is commonly identified by policy makers as a means ofreducing the pollution level, it does not provide sufficient incentives to the firms for inputsubstitution or market entry. Spulber showed that “while a lump-sum transfer is needed toprovide correct entry incentives when a Pigouvian output tax is applied, no such transfer isneed if the tax is correctly applied to effluent” (Spulber, 1985, p.103). With the lump sumtransfer, there is no incentive for input substitution.24In agriculture, incentive charges can be used mainly to reduce pollution damage.Inputs such as fertilizers and pesticides that have been directly linked to water pollution canbe the subject of taxes; producers are discouraged from buying such products due to theirhigher price. However, taxes on chemical inputs may become less effective as their level isincreased. Conversion charges can be applied to management practices that decrease drainagepotential of fields, and product charges can be applied to those products which, throughouttheir production process, pollute the environment. Shortle and Laughiand (1994) argue thatthe implementation of such environmental measures which increase agricultural productioncosts are not politically feasible unless accompanied by compensating adjustments in farmincome support policies.Subsidies, in general, conflict with the Polluter Pays Principle -- where the polluteris responsible for the clean-up of the polluting activity. In an agricultural context, however,subsidies can be awarded to those individuals who undertake the best management practices,which may not provide profit for the producer, but results in increased environmental benefitsfor society. Subsidies can also be given as incentives for producers to adopt environmentallysound practices and increase their innovation. The use of subsidies is advantageous asspecific individuals can be targeted, although they related only to current managementpractices. Subsidies can shift the level of marginal net private benefits and marginal externalcosts, changing the pollution and externality levels. By reducing the costs of clean-up,however, subsidies can actually encourage higher levels of externalities.Charges cum subsidy schemes, which combine both subsidies and charges, allow forthe advantages of both types of policies can be realized. “Such schemes could provide a25double incentive to reduce environmentally damaging activities: on the one hand, by chargeson fertilizers and/or pesticides, on the other hand, by subsidies for extensification measuressuch as completely abandoning the use of mineral fertilizers, pesticides, or growth regulators.”(OECD, 1991, pp.69,70)Tradeable permits create pollution rights, which can be bought or traded betweendifferent firms, and encourage less damaging environmental behaviour. Without a permit,environmentally damaging activities are considered illegal. In the United States, a fairproportion of the literature deals with the use of tradeable or marketable rights for large,water and air polluting industries. Such tradeable regimes rely on government set levels foremission reductions and the imposition of penalties for their enforcement. In this sense,tradeable permits are similar to command and control type policies, although they achievetheir desired results at a lower overall cost. Each firm can adjust their marginal costs ofproduction to the pre-specified maximum emission levels.The design of these trading policies is integral to their overall success. “Issues suchas how well the initial allocation is defined, who can trade with whom, barriers to trading,and ensuring that environmental goals are met are crucial to the political economy of design.Trading works best if integrated into the rules from the outset, rather than as an ‘add-on’.The starting points of the trading must be clear. Finally the trading works better ifallocations can be defmed in terms of quantities of emissions, not rates” (Doem, 1991, p.10).In general, the U.S. experience suggests that the potential for cost savings from the use oftradeable permit regimes is significant.26Refundable deposits are assigned to products which can be returned to their producers,thereby decreasing the potential damage stemming from their use. While the major focus ofthese financial incentive are aimed at pollution problems, they can also be very useful inachieving a level of sustainability. Resource depletion taxes and quotas can be set such thatthe amount of extraction permitted is within the pre-determined limits of sustainability forthat resource. These are particularly useful in renewable resource extraction cases.These economic instruments have been established to address problems and conflictswhich arise when market mechanisms have appeared to fail. Through the implementation ofsuch instruments, producers are induced to change their management practices if they wishto maintain their current levels of return. In the early 1990s, the Canadian federalgovernment published the Green Plan consultation paper “A Framework for Discussion onthe Environment”, the key argument of which was that “market approaches must be utilizedto a far greater extent as a complement to regulation. This is because market approaches --the use of tradeable pollution permits, taxes and charges -- can achieve environmental goalsas well as, or better than, an exclusive reliance on traditional regulation but at less overallsocial cost” (Doern, 1991, p 1).While the aforementioned economic instruments are commonly used to addressgeneral pollution problems, they may not all be sufficient in addressing the problem ofagricultural water pollution. Hence, the following section summarizes the literature pertainingto the abatement of agricultural water pollution, and highlights those instruments which arecommonly used in this field of study.272.3 Economic Instruments in PracticePollution can be classified as either point or non-point externalities. A pointexternality exists when pollution emissions are non-stochastic and can be monitoredaccurately by the source (Shortle and Dunn, 1986). On the other hand, agricultural run-offand leaching of nitrates into ground water are classified as non-point pollution externalities.The flow of pollutants from such non-point sources cannot be monitored on a continuous andwidespread basis with reasonable accuracy or at reasonable cost. “Without monitoring,regulations on emissions cannot be directly enforced, and charges or subsidies cannot beassessed. The non-point nature of agricultural run-off and leaching renders traditionalpollution policies inoperative because these policies must identify the externality contributionsof each economic agent” (Griffin and Bromley, 1982, p.551). Hence, some of theaforementioned environmental policies may not be effective in dealing with agricultural non-point pollution.There is a vast literature pertaining to non-point pollution from agricultural activities.As non-point pollution stems not only from nitrate pollution, but also from soil erosion andother chemical leaching and run-off, the following review of past studies deals with all sourceof non-point pollution. These economic studies have determined that under different industrystructure and settings, certain economic instruments which may be ideal for addressing theproblem of non-point negative externalities in one instance may not meet the same objectivein another.Miltz, Braden and Johnson (1988) examine non-point source pollution control basedon soil erosion. They conclude that a soil erosion tax is more cost effective than a soil28erosion standard, except at the iT critical level. This tax effectively encourages the reductionof soil erosion on low abatement cost lands. The advantage of such a tax is that itdiscriminates according to abatement cost variability. Sharp and Bromley (1979) mention,on the other hand, that the primary policy instrument that has emerged is not a tax but ratheran on-farm standard, such as tons of allowable soil loss.Jacobs and Casler (1979) examine the internalization of externalities stemming fromphosphorus discharges from crop production to surface water through effluent taxes versusuniform reductions. They conclude that, due to the difficulty in estimating the marginalsocial cost and benefit curves, the implementation of a socially optimal standards forenvironmental water quality could be achieved through the effluent taxes.Jacobs and Timmons (1974) suggest that agricultural production practices can beeffective in reducing soil and phosphorus losses but the costs to farmers is substantial. Theymention that if a farmer or polluter is to bear the costs, a tax levied on all crop and pastureland in a watershed is likely to provide a more equitable distribution of costs than a tax ononly the land where the control measure is taken.Shortle and Dunn (1986) examine the relative expected efficiency of four generalstrategies for agricultural non-point water pollution abatement. They conclude that theimposition of appropriately specified management practice incentive generally outperformsestimated run-off standards, estimated run-off incentives, and management practice standardsfor reducing agricultural non-point pollution. The logic behind this conclusion is that anappropriate management practice incentive has a greater capacity to induce a farmer to choosemanagement practices that maximizes net social benefits. An economic incentive for farm29management practices is a tax or subsidy directly based on the management practice chosenby the farmer.Taylor and Frohberg (1977) conclude that the use of nitrogen fertilizer restrictionswould clearly be to the disadvantage of an individual landowner if imposed only on his farmbut would be to his advantage if imposed in a large region. They mention that thecompliance costs associated with nitrogen restrictions would be high, and random spot checksmay be required. They suggest that while other nitrogen policies have lower enforcementcosts, such as taxes and markets for pollution rights, they would not be as effective incontrolling the intensity of use as a restriction. If the intensity of use, rather than theopposition to total use, is the major factor causing unacceptable nitrate levels of water, thenper acre restrictions may be the best alternative.Homer (1975) analyzes the internalization agricultural nitrate pollution externalities.He concludes that a specified level of water quality can be achieved at the lowest possiblecost by using a system of charges against emitters, assuming the transaction costs are equalfor each alternative. The imposition of the pricing and standards approaches causes someagricultural production adjustments in cropping patterns and resource use.Moxey and White (1994) compare different nitrate abatement policies for non-pointnitrate pollution in Northern England. These policies include nitrate emission quotas, generalnitrogen input quotas, and nitrogen input quotas which depend on different land classes. Theresults of their research indicates that nitrogen input quotas are a more feasible option tocontrolling nitrate pollution than nitrogen emission quotas.30Pan and Hodge (1994) determine that leaching controls are substantially more costeffective in reducing the level of nitrates in water than are taxes. They also determine thata system of permits on land use is relatively cost effective and offers an administrativelyfeasible alternative to leaching controls. Their research pertains to watersheds in EasternEngland.Govindasamy and Cochran (1994) analyze the alternative ways to control poultry litterapplications to prevent problems from nitrate, phosphorus and bacterial loadings. Theyconclude that per ton litter taxes, land taxes on litter applications, quantity restrictions onlitter application, and a permit system to control litter applications are all effective incontrolling the level of poultry litter applied to land.As the above suggest, nitrate pollution control could be achieved by means of a tax,charge or permit system. In order to determine the level of this pollution control, however,these systems must be linked to the environmental damage arising from nitrate pollution.However, “in practice, this is complicated by the uncertainty with respect to theinconvenience and valuation of damage caused and the difficulty in identifying pollutionsources and hydrogeological relationships” (Pan and Hodge, 1994, p.104). Theaforementioned studies analyze nitrate pollution through linear programming models. Theyassume an exogenous inorganic nitrogen fertilizer market, wherein the producers purchasesare not a function of their activities. They mainly focus on the maximization of budgetshares, rather than on the actual production activities of the economic agents.Nitrate pollution, and the associated economic analysis, should focus on the level ofnitrogen inputs used in production, as shown through fertilizer applications. The non-linear31programming model developed in this thesis concentrates on the formation of instrumentswhich can be used to curb nitrate pollution at the nitrogen source. The above studies assumethat inorganic fertilizer is used solely in production. This may not be the case as manyagricultural producers utilize both inorganic and organic fertilizers. Hence, the origin ofnitrogen used in production must be assessed and instruments must be designed to decreasethe actual use of these nitrogen sources. In this way, the production decisions of theindividuals can be analyzed directly. When a fertilizer tax, or a permit for fertilizer use, isemployed, farmers make adjustments in their production decisions so that the value of themarginal product of fertilizer use equals the fertilizer price plus the tax or permit price (Panand Hodge, 1994). An input tax may not result in the same level of production as previouslyfound under other nitrate pollution control scenarios, but it would decrease the actual levelof use of the polluting generating substances. Therein, the difficulty in evaluating damageand pollution generating functions could be avoided and damage could be assessedqualitatively.32CHAPTER THREEMETHODOLOGY3.1 Conceptual ModelAs mentioned in Chapter 2, other studies dealing with non-point pollution fromagriculture have mainly developed linear programming models wherein budget shares areminimized. The model used in this thesis differs from those of other studies as three agentsare active in the manure market. The manure, which is produced by an agent who alsodemands manure, is one of two substances which can cause nitrate pollution. In otherstudies, the social damage assessment has stemmed from soil and inorganic fertilizercontamination of water, rather than from manure pollution or a combination of manure andinorganic fertilizer pollution. Therefore, similar studies and models are unavailable. Theconceptual model presented below and is described mathematically later in this chapter. Theempirical results are presented in Chapter 5. It should be noted that the conceptual modeldescribed does not address the inherent transportation costs incurred; this is done forsimplicity.3.1.1 Overall Model DescriptionThe overall model, shown in Figure One, is comprised of three agents: a vegetableproducer, a dairy producer, and an alternative nitrogen user, such as a composter or manuretransporter. While each of these agents undertakes separate activities and operatesindependently, they are linked through a manure market. It is assumed that the farms are33located in an area where nitrate leaching and surface run-off of manure and inorganicnitrogen into ground and surface water is prevalent. Hence economic instruments can bedesigned to increase water quality. Each farm undertakes separate activities; the vegetableproducer is interested in maximizing profits, while the dairy producer is interested inminimizing costs, as his/her overall milk production is constrained through a quota. Thealternative nitrogen user, which will hereafter be called a composter, participates in themanure market through a pre-specifled demand function. Each of these individualoptimization problems is discussed separately below and then in the context of the overallmodel.The key objective of this model is to determine whether social damage associated withnitrate pollution of ground and surface water from agricultural activities can be decreasedthrough the use of economic instruments. The actual occurrence of damage is dependent onthe activities of each economic agent. Therefore, alterations in each individual’s activities,and hence the optimal level of their associated objective functions, will either increase ordecrease the amount of societal damage and the associated negative externality. Once thebase case model is completed, taking into account the optimization problems of each agent,and the input levels are assessed, the use of economic instruments is explored. Thesequantitative and price instruments, aimed at decreasing the level of negative externalitiesassociated with nitrate contamination, will be analyzed according to their marginal valuationor shadow values.343.1.2 Base Case Model DescriptionThe demand for manure by the dairy and vegetable producers is dependant upon theproduction parameters and activities of each operation. These demands can be translated intovalue of marginal product (VMP) curves for manure (shown as VMPD and VMPV in panels2 and 3 of Figure Two), which display the benefit to each producer from using an additionalunit of manure, and are downward sloping and non-negative. The composter’s VMP curve(shown as VMPC in panel 1), which is specific to the composter’s demand curve, is alsodownward sloping, if the price of manure (denoted PM) exceeds the intersection of the price-based composter demand curve, the composter will have zero demand. if not, the composterwill demand some level of manure. The composter’s and vegetable producer’s VMP curvesfor manure can be horizontally summed to provide an excess demand curve (given by ED ispanel 3).As the supply of manure is fixed (given by schedule S in panel 2), an excess supplycurve (given by ES is panel 3) can be established. This excess supply curve represents thelevel of manure which would be available on the market after the dairy producer satisfied hisown demand (shown as DM in panel 2). The intersection between the excess supply and theexcess demand curves (given by a in panel 3), provides the market price for manure (denotedby M) This price determines the level of manure used by the dairy producer, in additionto the level shipped to the other economic agents. The combined demands of the vegetableproducer (shown as VM in panel 3) and the composter (shown as CM in panel 1) must equalthis shipment level.35Social damage can result from the over application of manure. Hence the VMPcurves for each of the vegetable and dairy producers can be shifted to the left reflecting thesocial VMP associated with manure demand (shown by social VMPD and social VMPV inpanels 2 and 3, respectively). This can be translated into a disvaluation of the marginalproducts stemming from social damage. The amount of these shifts is dependent on the levelof the non-point externality associated with manure use in each of the operations. If theoccurrence of the externality is greater for the dairy operation than for the vegetableoperation, the size of the disvaluation shift will be greater for the dairy producer.The inclusion of damage in the VMP curves shifts the excess supply and excessdemand curves from their previously equilibrium positions (from ES and ED to ES’ and ED’in panel 3) to intersect at point b. Hence, the manure price decreases to the point where thecomposter’s choke price exceeds the manure price, resulting in the composter’s participationin the manure market. The quantity of manure demanded by both the vegetable and dairyproducers decreases (from VM and DM to VM’ and DM’ in panels 2 and 3, respectively),as the quantity of manure demanded by the composter increases (from CM to CM’).This base case scenario, shown in Figure Two, demonstrates the difference betweenthe market based solution versus the socially optimal solution to the manure market. If themarket solution were to prevail, the composter would not enter into the manure market,resulting in the conclusion of composting being an economically infeasible alternative formanure disposal. Such a conclusion is consistent with the fmdings of Athwal (1994), whodetermined that the amount individuals were willing to pay to increase water quality wasinsufficient to cover the costs associated with composting, hence rendering composting an36economically infeasible activity. On the other hand, however, when the level of socialdamage stemming from nitrate contamination of ground and surface water is included, as isshown through the changed social VMP curves, the composter would be active in the market.This participation would result in the provision of a social benefit.3.1.3 Vegetable Manure TaxThe inclusion of a percentage manure tax into the objective function of the vegetableproducer increases the manure price (from M to P in panel 3, Figure Three), therebychanging the associated derived demand and resulting in a decreased demand for manure(from VM to VM’). This causes the vegetable producer’s VMP curve to shift inwards by theamount of the tax, as is shown by the moving of VMPV to VMPV in panel 3 of Figure Three.Hence, the ED curve also shifts inwards by the same level (from ED to ED’ in panel 3). Theintersection of the excess supply and demand curves (at point c) provides manure marketprice, which has decreased (from PMto PM). The level of manure demanded by the vegetableproducer decreases (from VM to VM’ in panel 3). The quantity of manure utilized in dairyfeed production increases (from DM to DM’ in panel 2), demonstrating that the quantity ofmanure transported between the dairy and vegetable operations decreases with the inclusionof such a tax. The composter will only participate in the market when the price of manureis less than his/her choke price (CHK). Hence, as this is the case, his/her demand increases,from CM to CM’ in panel 1. These shifts are essentially showing a movement towards thesocial optimum shown in Figure Two.37The main effect of the implementation of a percentage manure tax, as mentioned andshown in Figure Three, is the decreased manure transfer between the dairy and vegetableoperations. Hence, as more manure is left at the dairy farm site, the level of social damagemay increase. This change is a function of the physical attributes of the land base, whichwill determine the degree of nitrate leaching and surface manure run-off associated with theover application and mismanagement of manure. If these levels are known to be high, thenone can predict that the level of social damage would increase with the implementation ofsuch a tax. On the other hand, if the leaching capabilities of the vegetable producer’s landbase were higher than those of the dairy producer, the overall level of damage may actuallydecrease. Hence, the conclusions in terms of the actual changes in social damage of thismodel would rely solely on the physical attributes of each individual operation.As mentioned, with increasing tax rates, the manure price level decreases to a pointwhere the composter becomes active in the market. His activity, however, is limited.Therefore any benefits accrued from composting would be minimal when compared with thechanges in the vegetable and dairy producer’s manure demands and the potential resultingdamage.There will be an optimal level at which a tax rate should be set in order for the levelof damage resulting from nitrate contamination to decrease when a manure tax is introducedinto the model. The discovery of such a tax rate would require pre-specified knowledge ofan actual damage function, which, in the case of this thesis, is unavailable. The overallconclusion, however, implies that the implementation of a tax may not adequately address the38externality problem; it appears to simply facilitate the transfer of manure between differentregions.3.1.4 Composting SubsidyThe provision of a composting subsidy increases the level of the composter’s ‘IMPcurve by the amount of the subsidy (from VMPC to VMP in panel 1 of Figure Four), thereinshifting the excess demand curve outwards (from ED to ED’ in panel 3). The newintersection of the excess supply and demand curves occurs at point d. Such a shift in excessdemand increases the market price (from M to P), and decreases the levels of demand bythe vegetable and dairy producers (from VM and DM to VM’ and DM’, respectively). Theexcess supply curve (ES in panel 3) remains unchanged. As a result of the subsidy, thecomposter’s choke price (CHK) exceeds the manure market price, inducing the composter topurchase manure. His/her demand changes from CM to CM’, in panel 1.A composting subsidy is aimed at encouraging an environmentally positive productionactivity, by initiating both the an increase in the quantity of manure demanded by thecomposter and an associated decrease in those of the other producers. Hence, the level ofthe nitrate pollution should decrease as the levels of manure applied to the land by thevegetable and dairy producers decrease. If one of, or both of, their associated land bases issusceptible to nitrate leaching, the overall level of ground water contamination woulddecrease as a result of the implementation of the composting subsidy. The decreasedapplication of the manure to the land would also minimize the possibility of the over-application of manure and, therein, decrease the occurrence of surface manure run-off. Based39on qualitative analysis, it is concluded that, the level of social damage would decrease whena composting subsidy was provided by the government. It should be noted, however, thatsuch a subsidy may not be politically feasible if financial justification were not available.The changes in the market model resulting from the inclusion of a composting subsidy showa movement towards the social optimum described in section 3.1.2.3.1.5 Quantitative Manure Application LimitThe imposition of a manure application limit (denoted by M) does not effect the VMPcurves of any producer, as is shown in Figure Five. It does, however, effect the excesssupply curve, denoted by ES in panel 3. Previously, the excess supply curve was linear.With the inclusion of a manure application limit the quantity of manure utilized in feedproduction is restricted; hence, the excess supply curve becomes kinked (shown by ES’ inpanel 3). Until the point where the dairy limit curve intersects the VMP curve of the dairyproducer (denoted by e), the excess supply curve is vertical and linear. After this intersectionpoint, the curve becomes upwards and positively sloped, which is indicative of a standardsupply curve.The manure application limit forces more manure onto the market, causing the priceof manure to decrease (from M to PM). The quantity of manure demanded by both thecomposter and vegetable producer increases (from CM and VM to CM’ and VM’ in panels1 and 3, respectively). The sum of these quantities equals the difference between the totalamount of manure available (S) and the amount of the application limit restriction (M).40The change in the level of social damage resulting from the implementation of amanure application limit is again dependent on the physical attributes of the dairy andvegetable producer’s land bases. If the level of leaching and surface manure run-off fromthe dairy producer’s land exceeds that of the vegetable producer, then the overall level ofsocial damage would decrease. This decrease would be augmented by the increased level ofmanure composted which occurs as stricter manure application limits are imposed. On theother hand, however, if the vegetable producer’s land base were more susceptible to leaching,the overall effects on the level of social damage would be difficult to determine. Theincreased damage from higher vegetable manure applications would need to be comparedwith the decreased damage stemming from both decreased manure applications by the dairyproducer and the increased level of composting to determine the overall effects on damage.Again, these changes are indicative of a shift towards the socially efficient market outcomewhich is described in section 3.1.2. The composter becomes an active participant in themarket, and the manure demands of both the vegetable and dairy producers decrease.DJRYPRODUCER(minimisecosts)manuremanaement—MANURETESFEVEG. PRODUCER(maximiseprofits)IproducemilkIherdmaintenance—opsandtoragIcroprotationsJ—-—----—Fti—hirelabourIdrainago(———jcovercropF———------nitrogenacquisitionI-RUN-OFFCOMPOR(demandsmanure)LANDBASELEACHINGRUN-OFFLANDBASEcc (LEACHINGFIGUflEONE$.Pin CMCM’VMPFIGURETWO(1)Composter(2)DairyProducer(3)VegetableProducer$S$Pm’ESES’PmmanureEDED’DM’DMmanureVM’VMmanureBISECZSESENTRIOFIGURETHREE(1)Compoter(2)DairyProducer(3)VegetableProducerVEGETABLENANURETAX(%)$$ pmPm’$ESPmmanureFmED’manuremanure-$$FIGtJ1EFOURComposterDairyProducerVegetableProducerEb’EDS$PmPmESi—ill—Pm-VMPVMP-.CMCM’manure(1)(2)DM’DMmanureVM’VMmanure(3)WNURECOMPOSTINGSUBSIDY(%)FIGUREFIVE(1)Composter(2)DairyProducer(3)VMP$$$PmPm’Pm’ESCMCM’manureDMmanureEDmanureVM’VegetableProducerDMRYN1NUREAPPLIC1TIONLI4IT(M)463.2 Mathematical Specification of the Model - Without Economic InstrumentsThe purpose of the following section is to describe the activities of each economicagent in more detail and to mathematically expand the conceptual model described in Section3.1. As this model is designed to reflect real world situations, all possible external factorsmust be analyzed according to their potential influence on the model’s ability to solve theproblem at hand. Hence, the optimization technique, or the ‘quest for the best’, is used inthis thesis. It is a method of determining the best possible outcome from a pre-designedmodel. An objective is chosen for each agent that is a function of other model, or choice,variables. The fundamental theory of optimization is to determine the values of the choicevariables that yield the best level of the dependent variable and its associated objectivefunction. If the optimization problem is constrained, the Lagrangean technique can beutilized to convert the equality-constrained optimization problems into inequality-constrainedoptimization problems. The resultant Lagrange multipliers, or shadow prices, reflect theamount the objective function will increase or decrease with a unit relaxation of the bindingconstraints.In the conceptual description of the model (section 3.1), the demand and supplyschedules of the economic agents were assumed to be linear. In order for the mathematicalformulation of the model to be realistic, these linear curves were replaced by more flexiblefunctional forms in order to allow for substitution between fertilizer inputs. Hence, the nonlinear relationships of these equations requires that non-linear programming procedures areused to solve the optimization problems of this thesis.473.2.1 Dairy ProducerThe dairy producer minimizes his costs of production, while being constrained by aquota which restricts his overall milk output. Since there is a direct relationship between theamount of milk produced and the number of milking cows, there is no need to explicitlyaddress the issue of quota within the model. The feed required by the animals can either bepurchased through a competitive feed market with a perfectly elastic supply or grown by thedairy producer. The quantity of feed required, which is a function of the number of cows inthe operation, is directly related to the quantity of animal waste produced. This fixed amountof manure can either be sold to other economic agents, resulting in revenue for the dairyproducer, or used as a fertilizer input in the dairy’s crop production. Any additional fertilizercan be purchased through the inorganic fertilizer market at a fixed, exogenous price. If theprice of manure exceeds the price of inorganic fertilizer, the dairy producer will sell moremanure, and purchase inorganic fertilizer at a lower price, thereby decreasing his overallcosts. This is based on the assumption that manure and inorganic fertilizer are closesubstitutes.The dairy producer’s objective function is as follows:MIN Costs = WFQ;+WJDIWMg (3.1)where:WF = exogenously determined price of feed;Q = quantity of feed purchased by the dairy producer;W1 = exogenously determined price of inorganic fertilizer;DI = quantity of inorganic fertilizer demanded by the dairy producer;W = endogenously determined dairy producer’s price of manure;MSO1d = total quantity of manure sold.48The dairy producer will incur costs associated with the purchases of feed and inorganicfertilizer. These costs are shown through the first two segments of equation (3.1). Revenue,which is acquired through the sale of manure to the other agents in the model, is shown inthe final term of equation (3.1). This revenue decreases the costs associated with milkproduction.As previously mentioned, the dairy producer can either purchase or grow feed. The priceof purchased feed will help to determine if feed is grown as a production activity. If theprice of feed is high, the dairy producer will be induced to grow more feed. The ensuingfeed production can be depicted through a constant elasticity of substitution (CES) productionfunction. Such a function explicitly relates the proportions of inorganic and organic fertilizerinputs used in each unit of production and the production efficiency.A CES production function provides a constant elasticity of substitution between the levelof inputs used in the production process regardless of changes in the relative input prices.Depending on the value of one of the function’s parameter’s, p, the CES production functioncan take on a variety of shapes, some of which are special economic cases, such as theLeontief production function when p= - infinity. The shapes of the isoquants, or the levelsets of the production function, have important implications for the effect of changes in inputprices on the input mix used to produce a given output (Varian, 1992). It is the elasticity ofsubstitution that captures the relationship between the input ratio and the curvature of theisoquants. “Intuitively, the smaller is the elasticity of substitution the more ‘bowed in’ willbe the isoquants and the smaller the proportionate change in the input mix associated withany given proportionate change in the slope of the isoquant” (Gravelle and Rees, 1992, p.184.)49The dairy producer’s feed production, which is based on a CES production function, is:FEED = AD (aOD÷ aD (O.5DIfP ÷(1 -aD)(O.0O525DM))1JDP (3.2)where AD is the feed production efficiency parameter, indicating the efficiency level of thecurrent state of technology; aOD represents the intercept term and specifies the overall returnsto scale of the function1;c(], is the distribution parameter, which relates to the relative factorshares of each input used in the production of the final product; and Dp is the substitutionparameter, which helps to determine the value of the elasticity of substitution (Chiang, 1984).The levels of inorganic fertilizer (DI) and manure (DM) used by the dairy producer in feedproduction are multiplied by nitrogen conversion factors (0.5 and 0.00525 respectively).These convert the level of fertilizer applied into the actual quantity of mineral nitrogenavailable to the crop during production.2The total amount of feed required by the dairy producer must equal the sum of purchasedand produced feed, as seen in equation (3.3) below:TOTFD = Q+AD(aOD + aD(O.SD1)DP ÷(l aD)(O.00525DM)’P)1/DP (3.3)where TOTFD represents the total amount of feed required by the livestock and isexogenously determined, Q represents the quantity of purchased feed (endogenously1 For example, when aOD = 0 the model exhibits constant returns to scale, but when aOD>0, the model exhibits increasing returns to scale.2 These conversion factors are based on the fact that the average inorganic fertilizer contains50 percent nitrogen, and that for every tonne of manure there is 5.25 kilograms of nitrogen.These are explained more thoroughly in Chapter 4.50determined), and the CES production function represents the level of feed grown by the dairyproducer. Equation (3.3) constrains the dairy producer’s overall objective function.A second constraining factor is that the total amount of manure produced (Mi,ro), whichis an implicit function of the level of feed intake of the cattle, must equal the sum of thequantity of manure sold and the dairy producer’s own consumption. This is shown inequation (3.4).(3.4)Mpro = M+DMwhere Mi,ro represents the total quantity of manure produced, DM represents the quantity ofmanure utilized in the dairy producer’s own feed production, and M represents the levelof manure sold by the dairy producer.By incorporating these two constraints, and the cost minimization objective as shown inequation (3.1), into the overall optimization problem, a Lagrangean equation can beestablished to represent an equality constrained optimization, as shown in equation (3.5).= WFQ+DI-WM+?l (MproMso+DM)+2(TOTFD-Q--AD (ClOD + aD (0.5 DI)DP +(1 _aD)(O.OO525DI)1)P)1M)(3.5)Each of the constraints (equations (3.3) and (3.4)) is assigned a Lagrangean multiplier, theshadow value of which demonstrates it’s effect on the dairy producer’s cost minimizationobjective. By differentiating (3.5) with respect to the choice variables (DI, DM, MSOld, Q,and X), first order conditions can be obtained which show the dairy producer’s derived51demands for inorganic fertilizer, manure, and purchased feed, as well as the level of manuresold to other agents. These first order conditions are shown below.W1-0.5A2D(aOD+aD(°.51) P ÷(1 - (O.00525D P)h114-1(3.6)(aD(0.5D1)DPL) 0- -0.52AD(aOD÷aD(0.5D1)’+(l _cg,)(0.O0525DM)DP) (37)((l_,)(O.00525DM)DP) = 0• MD 111”so dW1.-) 0 (3.9)MproMsDM = 0 (3.10)TOTFD-Q -AD(aOD+aD(O.SDI) P ÷( 1- a(O.00525D .DP)I/DP = 0 (3.11)where:W = exogenously determined price of feed;TOTFD = total quantity of feed required;QF = quantity of purchased feed;W1 = exogenously determined price of inorganic fertilizer;DI = quantity of inorganic fertilizer demanded by the dairy producer;DM = quantity of manure demanded by the dairy producer;WM = endogenously determined price of manure; andMSOld = total quantity of manure sold by the dairy producer.523.22 Vegetable ProducerThe vegetable producer is interested in maximizing overall profits. Therefore, he/shemakes decisions regarding the profit maximizing level of output according to the type andmixture of inputs used in the production process. As the output price is exogenouslydetermined through a perfectly competitive market, the key management decisions surroundthe purchase of inputs. The producer must decide whether to acquire inorganic fertilizerthrough a perfectly competitive market, organic fertilizer (manure) from the dairy producer,or a combination of the two. The outcome to this decision will depend on the price levelsof the two commodities, and their relative substitutabffity. The vegetable producer, like thedairy producer, faces an exogenously determined price for inorganic fertilizer.Vegetable production occurs according to a constant elasticity of substitution (CBS)production function. Such a function explicitly relates the proportions of fertilizer inputs usedin each unit of production and the production efficiency. The CBS function is:VEG = Av(aov÷a11(O.5VJ)VP÷(1 -a)(O.OO525) (3.12)where VEG represents the level of vegetable output produced, A is the efficiency parameter,indicating the state of technology; a is the intercept term; c, is the distribution parameter,relating the relative factor shares in the product; and Vp is the substitution parameter, whichhelps to determine the value of the elasticity of substitution (Chiang, 1984). As with thedairy feed production function, the levels of inorganic fertilizer (VI) and manure (VM) usedin vegetable production are multiplied by nitrogen conversion factors (0.5 and 0.00525respectively) to convert the level of fertilizer applied into the actual quantity of mineralnitrogen available to the vegetable crop.53By assuming profit maximization, the CBS production function can be incorporated intothe overall objective function (equation (3.13)) of the vegetable producer, through the simpleeconomic fact that profits equal the difference between total revenues (or the market valueof produced output shown through the CBS vegetable production function) and total costs (orthe market value of inputs used). The overall objective function can be written asMAX =PA(a0+ (O.5 Jff)VP +(1 -ci )(000525VM)VP)W’P (3.13)—W1VI— ,,(1 +t)VMThe first order conditions (equations (3.14) and (3.15)) associated with such an objectivefunction yield the input derived demands for both inorganic and organic fertilizer. Thesefunctions are shown through the following:--: O.5PAv(aov+a ,(O.5 Jq)VP +(1 —g)(°•°0525Vli,4)VP)lII’P-’(3.14)(av(O.5lvPj_11i = 00.O0525PA(ao÷cXO.5 jq)Vp +(1 )(0525J)Vp)lIVP-1 (3.15)(1_aVxo.oos25vIvI)VPI_wMVu÷t = 0where:= the vegetable producer’s profit level;P = exogenously determined price for vegetables;VI = quantity of inorganic fertilizer demanded by the vegetable producer;VM = quantity of manure demanded by the vegetable producer;WI = exogenously determined price of inorganic fertilizer;W = endogenously determined price of manure faced by the vegetable producer;and= transportation cost of moving manure from dairy.Manure transported between areas can be used in the production of other goods byincreasing the nutrient content of the soils. These transportation costs, represented by t, may54include gasoline costs, trucking costs and manure collecting costs, and increase the manureprice faced by the vegetable producer. If this ‘full’ price is less than the price of inorganicfertilizer, the vegetable producer may still purchase manure regardless of the transportationcosts.3.2.3 Composter or Alternative Nitrogen ConverterAn individual could purchase manure from the dairy producer and compost it for usein other industries. Composting costs, currently estimated at $19 to $30 per tonne, dependingon the manure type and composting method, are substantially higher than the selling priceof less than $10 per tonne (Hauser, 1994). As this study is only concerned with thecomposter’s overall demand for livestock manure, these prices, although significant, are notincluded in the model. Demand for compost, which stems from both horticulture andsilviculture industries, as well as from households and gardening facilities, is determinedexogenously from the model.The actual amount of manure demanded by the composter (Mg) is a direct function ofthe market price for manure, as is seen in the following equation depicting the composter’sdemand function:M CHK-H (WMC) f WMC < CHK (3.16)= 0 fWMc>CHKwhere:M = quantity of manure demanded by the composter;CHK = intersection or choke point of the compost demand curve;H = slope of compost demand curve; andWMC = endogenously determined price of manure faced by the composter.55If the price of manure faced by the composter (WMC) exceeds the choke price (CHK), thecomposter will demand no manure. If the price of manure (WMC) is less than the choke price(CHK), the composter will demand some positive level of manure. As the difference betweenthe choke price and the price of manure increases, the level of manure demanded will alsoincrease. Economic theory suggests that a realistic choke price would be approximately 5percent below the market price. Therefore, at the market price, the composter would,theoretically, demand negative quantities of manure.3.2.4 Combined Market ModelIn order for the manure market to function correctly, and for and equilibrium to beachieved, market clearing conditions must be imposed. Firstly, the sum of the quantities ofmanure demanded by the vegetable producer (VM) and the composter (M) must equal thelevel of manure sold by the dairy producer (M0), as is shown below in equation (3.17):VM ÷ M (3.17)The second market clearing condition is that the price of manure that is received by the dairyproducer (W) must equal the price of manure faced by both the vegetable producer (W)and the composter (WMC), as is shown below in equation (3.18). This condition assumesprices which are net of manure transportation costs, taxes or subsidies.WM,, = WMV = WMC (3.18)These conditions bring together the three agents (dairy producer, vegetable producer, andcomposter), allowing them to operate independently and optimize their own objective56functions, while being linked through the manure market. The level of the market prices(both those exogenously and endogenously determined) will be reflected in the activities andinput demands of each agent. This combined model is considered the base case scenario anddoes not incorporate the use of economic instruments to decrease the level of social damagestemming from nitrate contamination of ground and surface water.3.2.5 Solution ProcedureIn order for a model solution to be attained, the first order conditions of the dairyproducer (equations (3.6) through (3.11)), vegetable producer (equations (3.13) and (3.14))and composter (equation (3.16)) are simultaneously solved, along with the market equilibriumconditions (equations (3.17) and (3.18)). In this way, an overall market model is established,allowing for both the optimization of the individual objective functions of each economicagent and the clearing of the manure market.3.3 Economic Instruments Model DescriptionThe overall objective of this model is to determine the effects of economic instrumentson the level of social damage resulting from nitrate pollution of ground and surface water.Such externalities result from both the over application and mismanagement of nitrogen basedfertilizers. As both the dairy and vegetable farmers use fertilizers in their production process,it is possible to analyze the level of damage which results from the leaching and run-off ofboth inorganic and organic fertilizers. Social benefits can be determined from the level ofcomposting undertaken, and the decreased levels of input use.57Theoretically, the level social damage should be minimized whenever economicinstruments are implemented to abate the occurrence of negative externalities. However, asthe mathematical relationship between the level of nitrogen applied and the resulting damageis unknown and often variable, it is difficult to determine the actual level of damagestemming from different production activities. In addition, the dollar values associated withdiffering levels of nitrate damage are unknown, making it impossible to assign a monetaryfigure to the social damage. Such values could be attained by asking individuals how muchthey would be willing to pay to decrease the amount of nitrate contamination of ground andsurface water. As such a contingent valuation study is unavailable, as are the actual damagefunctions, the social damage estimation undertaken in this study will be qualitative. It is feltthat this type of analysis is better suited to the problem at hand.When economic instruments, such as subsidies and taxes, are included in the optimizationmodel, the objective functions of, and constraints facing, the vegetable and dairy producers,and the composter are altered. Hence production decisions are changed according to theinfluences of these newly included economic instruments. Social damage analysis can occurthrough the examination of the levels of these choice variables. The changes in thesevariables will reflect the changes in the level of social damage as well as the constraintsplaced on the objective functions of each of the producers.583.3.1 Manure TaxAs previously stated, the aim of the vegetable producer is to undertake productiondecisions to maximize profits. When a manure tax is included in his/her objective function,a wedge is created between the actual manure market price and the price faced by thevegetable producer. Therefore, the previous management and production decisions (i.e., priorto the implementation of the tax) are no longer optimal and need to be altered. The resultantobjective function is shown below:MAX PA ,(O.5 17)) VP +(l V)(°°°525JqJ)Vp)lIVP(3.19)-W1VI-W,(l +t +tax)VMwhere tax represents a percentage manure tax which alters the vegetable producer’s manuremarket price. The other variables have been described previously. This function differs fromthe original objective function (equation (3.13)) by the inclusion of this manure tax variable.Essentially, this tax, coupled with the manure transportation costs, converts the manure pricefaced by the vegetable producer to a higher level. As the effective price facing the vegetableproducer increases, the demand for manure decreases, as has been shown in demand theory.This new derived demand for manure is shown in equation (3.20):0.00525PA(a0÷ccXO.5 J/J)Vp ÷(1 — cx V)(O.OOS2S1fVp-1(3.20)((1 cL)(000525VM) )WMV(1 ÷t ÷tax) = 0Through the direct implementation of a tax, the vegetable producer is faced with revenuegaining incentives to alter his production decisions to use less manure. Some public policiesaimed at reducing nitrate effluent involves imposing a tax on the final product, through a finaloutput tax. Spulber (1985) explained that, while such an approach is commonly identified59by policy makers as a means of reducing the pollution level, it does not provide sufficientincentives for input substitution by the producers. Compliance with input tax payments overtime encourages producers to substitute away from, or decrease their use of, nitrogen basedfertilizers towards other more sustainable fertilization means. With the inclusion of incentivecharges in agricultural production decisions, producers are discouraged from using substanceslinked to water pollution due to the higher purchase price. Taxes are included under thenotion of the ‘polluter-pays principle’.Theoretically, it has been shown that when taxes are included in the optimizationproblems, the level of damage affiliated with negative externalities decreases as the tax rateincreases. However, in this situation at hand, a fixed quantity of manure is produced, hencethe overall consumption of manure may not decrease. Although manure consumption by thevegetable producer will decrease as a result of the tax, the amount of manure available to thedairy producer could feasibly increase. Whether this manure is used in dairy crop production,causing a change in the level of social damage, will depend on the substitutability of fertilizerinputs and the relative efficiency of the dairy’s crop/feed production. The dairy producer alsohas the option of selling this manure to the composter.3.3.2 Inorganic Nitrogen TaxAn inorganic nitrogen tax can be implemented, causing the market price of inorganicfertilizer to increase by the amount of the tax. As both the dairy and vegetable producerspurchase inorganic fertilizer for use in their feed and vegetable production, respectively, theirobjective functions will be altered by this inorganic tax.60The vegetable producer’s resultant objective function is shown below:MAX it PAv(aov+C11(O.5VI)”1÷(1 -v)005251)” (3.21)-W1(1+jnotax)VJ—WMI,(l ÷)1’Mwhere inotax represents the implemented percentage inorganic fertilizer tax which increasesthe inorganic fertilizer price. This function differs from the original objective function(equation (3.13)) by the inclusion of this inorganic fertilizer tax variable. As the effectiveprice faced by the vegetable producer increases, the demand for inorganic fertilizer decreases,as is known from demand theory. The vegetable producer’s derived demand for inorganicfertilizer also changes, as shown in equation (3.22)::0.5PAv(aov+(1 ,(0.5 VI)VP ÷(1 -a)(0.00S25f71I,,f)VP)h/l’Pl (3.22)(av(0.517)v)_hhhi(1÷uhjotu) =0The dairy producer’s objective function also changes as a result of the inorganic fertilizertax, as is shown below in equation (3.23).MIN Costs = wFQ:+wJ(l+inoW.X)DIwMDMOw (3.23)This function differs from the original objective function (equation (3.1)) by the inclusion ofthe inotax, the percentage inorganic tax variable. As with the vegetable producer, the dairyproducer’s demand for inorganic fertilizer should decrease, according to economic theory, asthe tax rate is implemented and increased. The dairy producer’s derived demand forinorganic fertilizer, when the inorganic fertilizer tax is implemented, is shown in equation(3.24).61--;W(1÷inotax)-O.5). A8D1 2 D (3.24)(aOD+cD(O.5D1)’ +(1 - (O.OO525DM)j’P ‘(a (O.5D1)”P 1) = 03.3.3 Composting SubsidyA subsidy can be paid directly to the composter from the government. As a compostingsubsidy decreases the composter’s effective net price of manure (WM(), the actual amount thecomposter is willing to pay for the manure increases. As the level of the subsidy increases,it is feasible to say that the composter will demand more manure. The composter’s originaldemand function (equation (3.16)) is altered to reflect the inclusion of this subsidy, as isshown below:M’ = HK-H(WMc-S f (W—S) < HK (3.25)= 0 if (WMcS) > CHKwhere S represents the government composting subsidy. If the subsidy is set at zero, thedemand function remains unchanged. As composting decreases the level of manure availableto both the dairy and vegetable producers, the level of social damage should decrease as moremanure is composted. This decrease is equivalent to an increase in social benefits or socialwelfare.Athwal (1994) analyzed manure composting as a solution to the Abbotsford Aquifernitrate pollution problem. She focused on whether government composting subsidies areworthwhile from a social point of view. The contingent valuation estimated the amount thathouseholds are willing to pay for improved water quality in the area ($81.03 to $139.22 perhousehold). This value is not considered to be sufficient to adequately cover the costs and62losses a livestock producer would incur from composting all of his/her manure. She statesthat “public subsidies to agricultural producers will simply encourage composting which costsmore than it benefits society” (Athwal, 1994). This conclusion, it should be noted, is basedon an ‘all or nothing’ approach to composting. Some composting may be beneficial.Through the establishment of the pre-specifled manure market, wherein three different agentsmeet individual objectives, it would not be feasible that the full quantity of livestock manurebe composted, even if the government composting subsidy was set at an extremely high level.Some manure would still be required by both the dairy and vegetable producers. Hence,composting in this situation is deemed socially feasible.3.3.4 Quantitative RestrictionsQuantitative restrictions, such as manure application limits, are another form of economicinstrument which can decrease the level of social damage. Such a limit can be establishedfor the dairy producer. This would limit the amount of manure which the dairy producercould use in feed production, forcing more manure onto the manure market. The marketprice of manure would be depressed, thereby enticing the other agents to purchase moremanure. The objective function of the dairy producer is altered by the inclusion of such anapplication limit, as is shown in equation (3.26):63W1.Q+WDI-WMDMSOW+A (M-M÷DM) +(3.26)2(TOTFD_QPF_AD(aOD+aD(O.SDI) P ÷(l - (O.OO525DM)1)P)1)where DM represents the manure application limit. The actual manure demands of both thevegetable producer and the composter will be altered as the quantity of manure available inthe market has increased causing a change in the manure price.3.3.5 SummaryThese economic instruments could be implemented either independently or in tandem.All that is important is that the economic instruments are established such that productionbehaviour of the manure market participants is altered. Both taxes and subsidies providefinancial incentives to change management behaviour. They can discourage harmfulmanagement practices and promote good ones. Taxes and subsidies can be implementedconcurrently, allowing for the tax revenue to provide the financial backing for the compostingsubsidy. In this way, composting could become an economically feasible activity.Application limits, or quantitative restrictions, can limit the level of manure applied to areaswhich are susceptible to leaching while decreasing the manure market price to a level wherethe composter would actively participate in the market and provide a socially benefittingactivity.Each of the aforementioned economic models is evaluated independently and analyzedfor their individual relevance for solving societal damage problems stemming from nitratecontamination of ground and surface water. The desired result is for the level of the negative64externality to decrease along with the social damage when economic instruments areimplemented. This may or may not occur when instruments are ensconced together, althoughthe model should be adequately parameterized for producer’s management decisions tochange when at least one of the economic instruments is put in place. The alteration in socialdamage can then be qualitatively determined and evaluated.The values of the model parameters, as well as a discussion of the data used in thisthesis, are found in Chapter 4. The results of these models are provided in Chapter 5. Eachmodel is analyzed independently and then compared with the other models to determinewhich allows for the highest overall benefit to society.65CHAPTER FOURDATAThe values of the model parameters are estimated such that the model provides a properrepresentation of the real world. Each producer’s optimization problems must reflectsituations that would be encountered in daily management decision making scenarios. Hence,the values of the parameters are set to exhibit these decisions.4.1 Dairy ProducerAs described in section 3.2.1, the dairy producer’s aim is to minimize overall productioncosts subject to two different constraints. The overall Lagrangean representing this equalityconstrained optimization is shown in equation (3.5). The first constraint is that the totalamount of feed required by the livestock must equal the sum of purchased and produced feed,and secondly, the amount of manure produced by the livestock must equal the sum of thequantities of manure sold and the dairy producer’s own consumption.The parameters of the CES feed production function can be estimated through the useof real world production data.3 In the south coastal region of British Columbia, a commondairy production activity is to plant a summer corn-silage crop followed by a spring harvestedwinter-wheat (WW) cover crop. Numerous studies (Cain (1992); Bomke and Temple (1989);Bomke and Hogan (1989)) have been undertaken to determine the input requirements andThe data used in this study was taken from “The Economics of Winter Wheat for Silageon Dairy Farms in South Coastal British Columbia” by Laura Cain, 1992.66accompanying output associated with such feed production in this area. Table 4.1, taken fromCain (1992) p.12, summarizes the input requirements and yields for the winter-wheat andcorn cropping systems.Table 4.1 Input Requirements and Yields of Winter Wheat and Corn CroppingSystemsYields Corn-Silage WW-Silage (Spring) AverageDry Weight (tonnes/ha) 12-14 7-10 10.75Wet Yield (tonnes/ha) 46-56 @ 26% DM 24-33 @ 30% DM 39.75Fertilizers units used units/ha units/ha totalunits/hamanure N app/ha4 1 1 234-0-0 kg/ha 0 0 046-0-0 kg/ha 380 0 38011-55-0 kg/ha 90 0 90Under the assumption that these yields and input requirements are homogeneous acrossdairy farms, real world simulations of production activities can be assessed under the CESfunctional form. Such assessments can help to determine the values of the parameters of theCES feed production function used in this thesis. By aggregating the level of inorganicfertilizer used in typical dairy feed production (the sum of the levels of 34-0-0, 46-0-0, and11-55-0 utilized), and assuming a 50 percent nitrogen recovery rate, an overall inorganicfertilizer input level is attained. On average, in the southern region of British Columbia, thelevel of inorganic fertilizer used in dairy feed production is 470 kg, or 235 kg of recoverablenitrogen. The total quantity of manure utilized in feed production, 250 kg of manure N, is‘ One application of manure per hectare assumes 125 kg/ha of manure nitrogen.This number is less than shown in the source copy of this table, as interviews with industryrepresentatives suggested than this level was too high.67determined by summing the level required in both corn silage and winter wheat silageproduction. Employing the fact that one tonne of dairy manure provides 5.25 kg nitrogen6,an overall manure requirement of 47619.05 kg of manure is estimated. These values, coupledwith the average level resulting production output of 10.75 tonnes/ha of dry matter, are usedto estimate the parameters of the CES production function. The results of these parameterdetermining simulations are found in Table 4.2 below, which describes these parameters andtheir associated values.Table 4.2 Dairy Feed Production Function ParametersPARAMETER NAME PARAMETER DESCRIPTION LEVELAD feed production efficiency parameter 1 .8E-06a0J) feed production intercept term 3c feed production distribution parameter 0.48Dp feed production substitution parameter 0.9The combined effects of the parameters of the CES production function and theexogenous prices for inputs help to determine the quantity of feed grown by the dairyproducer. The parameter AD, the efficiency or technology parameter, is 1.8E-6. This levelreflects external technological influences on the dairy producer’s operation. The interceptterm, a, which exhibits the level of feed production when no fertilizer inputs are used in theproduction process, is equal to 3. This value is representative of the residual levels ofnitrogen present in the soils; higher nitrogen concentrations in the soil may lead to greater6 This value was attained through a personal telephone interview with Orlando Schmitz,Livestock Specialist, B.C. Ministry of Agriculture, Fisheries and Food conducted on July 7, 1994.68output when no fertilizer inputs are used in production. In this case, it may representresidual manure, and therefore nitrogen, present after the dairy cattle have grazed on the land.The distribution parameter, an, which provides an indication of the relative input factorshares used in feed production, is equal to 0.48. The level of manure nitrogen used inproduction is slightly greater than the level of inorganic fertilizer nitrogen (0.5 x 470 kginorganic fertilizer = 235 kg inorganic N/ha versus 250 kg manure N/ha).Dp, the substitution parameter for the dairy producer’s CES production function, equals0.1. As the value of p increases towards one, the inputs increase in their relativesubstitutability to become perfect substitutes. In addition, this value indicates that the dairyproducer’s feed production is only slightly affected by changes in the relative prices ofinorganic and organic fertilizers. As organic fertilizer is a by-product of milk production, thedairy producer’s manure use may be less affected by changes in manure’s relative price.The average milking dairy cow (1400 lb Holstein) in British Columbia requires 8395 kgof feed per year (approximately 13.6 kg/day) and 90 kg/day of water. Each cow produces19909 kg/year of manure (excluding bedding), or 54.55 kg/day. This level of manureprovides approximately 104.52 kg N/year or 0.286 kg N/day.7 The proportionality constantbetween the amount of manure produced and the amount of food intake is therefore 0.422.‘ These values were attained through a personal telephone interview with Orlando Schmitz,Livestock Specialist, B.C. Ministry of Agriculture, Fisheries and Food, conducted on July 7,1994.69Dairy manure is 13 percent solid, with 5.25 kgltonne of incorporated nitrogen, 2.4 kg/tonneof unincorporated nitrogen, 1.4 kg/tonne ofP205, and 5.3 kg/tonne ofK20.8The current market price of purchased feed, $90/tonne, is determined by averaging thecurrent market prices of different grain and straw/wheat silages.9 The exogenouslydetermined price of inorganic fertilizer is $0.369/kg.1° These prices and constants aresummarized below in Table 4.3.Table 4.3 Additional Parameters of the Dairy Producer’s Objective FunctionPARAMETER NAME PARAMETER DESCRIPTION LEVELW price of purchased feed ($Itonne) 90.0TOTFD feed required (kg/cow/yr) 8395MPRO manure produced (kg/cow/yr) 19909W1 price of inorganic fertilizer ($/kg) 0.3694.2 Vegetable ProducerAs previously mentioned, vegetable production occurs according to the CBS productionfunction given in equation (3.12). The benefits from using such a production function is thatit can yield a constant elasticity of substitution of a value other than one, the perfectsubstitutes case.8 These values were taken from Table 17, p.92, Soil Management Handbook for the LowerFraser Valley, B.C. Ministry of Agriculture, Fisheries and Food, 1991, Second Edition. Thevalue for incorporated nitrogen/tonne manure was obtained through a personal interview withOrlando Schmitz, Livestock Specialist, B.C. Ministry of Agriculture, Fisheries and Food,conducted July 7, 1994.This price is an average of the current (1994) market prices for different feeds.10 This is an average of the current (1994) market prices for different inorganic fertilizers.70Vegetable production data was made available from the B.C. Ministry of Agriculture,Fisheries and Food through the Planning for Profit Factsheets. As the Lower Fraser Valleyis a region of diverse vegetable production, data from an array of common crops wasattained. The vegetable production data sheets used in this study are: Head Lettuce (Agdex#251-810); Yellow Onions (Agdex #251.7-810); Celery (Agdex #252-810); Early Cabbage(Agdex #252-810); and Topped Carrots (Agdex #258-810). These crops were chosen as theirassociated production data pertains directly to the Fraser Valley region, and secondly, theproduction of each requires manure inputs. The use of different quantities of manure andinorganic fertilizers in the production of each of these crops results in different yields/ha.Hence, averages of their associated input requirements and output production could beestimated.” These levels were compared with those of the feed production of the dairyproducer to help determine the values of the CBS production function for the vegetableproducer.The average levels of manure nitrogen and inorganic fertilizer nitrogen utilized invegetable production, 248 kg manure N/ha (or approximately 47238 kg of manure) and 268.5kg inorganic N/ha (or 537 kg inorganic fertilizer) respectively, are similar to those levelsutilized in dairy feed production. The average vegetable producer in southern BritishColumbia produces 15.79 tonnes/acre, or 39.46 tonnes/ha of vegetable matter, while theaverage dairy producer produces 10.75 tonnes/ha dry matter or 39.75 tomies/ha wet matter.The levels of the inputs required and output produced are shown in each of the mentionedPlanning for Profit Factsheets. Any conversions undertaken between imperial and metric unitswere done in accordance with the conversion rates outlined by the Ministry of Agriculture,Fisheries, and Food in the Vegetable Production Guide for Commercial Growers. p.133.71These differences in output quantities are displayed through the differences between thevalues of A and AD, and aov and aOD. Table 4.4 outlines the vegetable producer’s CESproduction function parameters.Table 4.4 Vegetable Production Function ParametersPARAMETER NAME PARAMETER DESCRIPTION LEVELA efficiency parameter 2E- 14a intercept term 30cx distribution parameter 0.52Vp substitution parameter 0.1The efficiency parameter, A set at 2E-14, provides an indication of the state oftechnology used in vegetable production, and is comparable with the AD parameter of thedairy feed (CBS) production function. The intercept term, a, indicates the relative level ofvegetable production which would occur if no fertilizer inputs were utilized in the productionprocess. It’s value, of 30, indicates that for some level of production to occur, vegetableproducers may not require fertilizer inputs. This may not, however, reflect the heterogeneousconditions of vegetable production in the Lower Fraser Valley region, as some producers inthis area may be dependent on fertilizers for crop growth.The distribution parameter, a, provides an indication of the relative input factor sharesin the resultant product. The vegetable production data shows that the average vegetableproducer requires more inorganic nitrogen fertilizer than manure fertilizer (0.5 x 537 kginorganic fertilizer/ha = 268.5 kg inorganic fertilizer N/ha versus 250 kg manure N/ha).Hence, the value of c is set at 0.52, demonstrating that vegetable producers use relativelymore inorganic than organic fertilizers in production.72Vp, the substitution parameter, determines the value of the constant elasticity ofsubstitution. As mentioned previously, the value of p reflects the substitutability of theinputs. As p increases towards one, the substitutability increases. As the vegetable producerassumes the same level of substitutability between the inorganic and organic fertilizers as thedairy producer, p is equal to 0.1. p also reflects how changes in input prices alter the inputmix and, hence, the production of the given output.The overall objective function of the vegetable producer is to maximize profits, as isshown in equation (3.13). Table 4.5 outlines additional parameters of the vegetableproducer’s profit maximization objective function.Table 4.5 Additional Parameters of the Vegetable Producer’s Objective FunctionPARAMETER NAME PARAMETER DESCRIPTION LEVELP vegetable output price ($/tonne) 200W1 inorganic fertilizer price ($/kg) 0.369-v transportation cost (%) 50The aggregated value of the five different vegetable output prices for the crop data usedin the model estimation, which can be found in the Planning for Profit Factsheets, is$400.86/tonne.’2 The vegetable output price used in the estimation of this model is12 The average prices for selected vegetables produced in the lower Fraser Valley are asfollows: $8.44/case for head lettuce, $31 1.67/ton for yellow onions, $10.69/case for celery,$7.85/case for early cabbage, and $330/ton for topped carrots. On average there are 24heads/case and each case weighs 44 pounds. This information was attained from a telephoneinterview with Wayne Odermatt, Provincial Fresh Vegetable Specialist with the B.C. Ministryof Agriculture, Fisheries and Food, conducted June 27, 1994. Any conversions undertakenbetween imperical and metric units were done in accordance with the conversion rates outlinedby the Ministry of Agriculture, Fisheries and Food, in the Vegetable Production Guide forCommercial Growers, p.130.73$200/torme. This price is assumed to be the on-farm, pre-harvest vegetable price, or, in otherwords, the price an individual would pay for the crops which were still in the field. Itexcludes any additional post harvest input costs, such as co-op charges, washing and gradingcosts, and carton costs.As a true dairy manure transportation cost could not be attained, the transportation cost,-r, is assumed to be 50 percent of the actual manure market price. Since each tonne of dairymanure only provides 5.25 kg of mineral nitrogen, large volumes must be transported if anindividual’s nitrogen demands are to be met. This percentage representation of thetransportation costs provides an adequate illustration of the costs which would be incurredwith the transportation of such high volume of manure. Transportation costs are subject tochange depending on the type and liquid content of the manure, as well as from fluctuationsin fuel prices. They are determined exogenously from the model, and are considered fixedper unit of manure transported between the dairy and the vegetable operations. The currentaverage cost associated with transporting blended and pure poultry manure is $65.7 15 pertonne of manure transported.’3 This value was not used in the estimation of the model aspoultry manure is of a higher solid manure content than dairy manure. If this figure wereused it would inadequately represent dairy manure transportation costs. The price ofinorganic fertilizer, W1, is $0.369/torme. This price is determined through an exogenousmarket and is unaffected by the actions of the economic agents participating in the manuremarket.13 Cain, Hauser and van Kooten (1993), p.4.8, states that the transportation cost for blendedpoultry manure and sawdust is $90.80/tonne, while for poultry manure alone is $40.63/tonne.The value of $65.7 15 is an average of these two figures.744.3 ComposterEquation (3.16) outlines the composter’s demand curve. According to economic theory,this demand curve must be downward sloping and intercept the y-axis at the point of zerodemand, which is known as the choke price (notated by CHK). A realistic choke priceshould be 5 to 10 percent lower than the actual market price. In this way, if the true marketprice exceeds the choke price by any amount, the composter could, theoretically demandnegative quantities of manure. The choke price for the composter is set at $0.003 16/kg ofmanure, or $0.593/kg manure nitrogen, and is associated with a zero composter manuredemand.’4 If the choke price ($/kg) is greater than the price of manure, which may occurwhen different economic instruments are introduced into the market, the composter willdemand positive levels of manure. If the choke price is less than the price of manure, thecomposter’s demand will be zero. The slope of the demand curve is 5E-8. Theoretically, itwould be desirable for the elasticity of the composter’s demand curve to be close to e=-l.In this case, however, the elasticity of the composter’s demand curve is approximately90,000. This value is exceedingly high, and should not be considered an accuraterepresentation of a composter’s demand elasticity. The estimated parameters of thecomposter’s demand curve are, however, used in the model estimation despite this highelasticity, as of the following. When these parameters were employed to estimate thecomposter responsiveness to changes in the market price of manure, it was found that thechanges in the quantity of manure demanded were quite realistic to the level of the priceUnder the base case scenario the market price of manure is $0.0033 17/kg of manure. Asmentioned, a realistic choke price should be 5 to 10 percent lower. Hence, the choke price iscalculated at $0.003 16/kg of manure, or approximately 5 percent below the base case price.75changes. For this reason, the elasticity value is ignored, and the estimated parameters areused.As the composter is interested in purchasing a quantity of manure, this price-baseddemand curve must be inverted to become a quantity-based demand curve. Hence, the valuesof the choke price and the slope must be converted to remain consistent with the quantity-based demand. The choke level, which is calculated by dividing the choke price(CHK=$0.0031 15/kg) by the slope of the composter’s demand curve (H=5E-8), is 63200.The slope level, which is calculated by inverting the value of the slope of the composter’sdemand curve (H=5E-8) is 20000000.4.4 Model CalibrationIn order for the model to provide an satisfactory representation of real world production,it is important that an adequate land base be used for the model estimation. This land baselevel will help to determine the actual level of inputs required by both the vegetable and dairyproducers. The level of feed produced/ha must be examined to determine the number ofcows that this can sustain, and the total level of manure produced by these cows must beassessed. It is important, however, to ensure that some feed is purchased through theexogenous feed market.’5If feed production is assumed to occur on a 1 hectare land base, producing, on average,10.75 tomies of feed, the amount of manure required is 47619.05 kg (resulting in 250 kg N).15 Commonly, dairy producers purchase some feed through feed market. On average,between 50 and 70 % of feed is purchased, however, this will depend on the size of anindividual’s land base.76If vegetable production is assumed to occur on a half hectare basis, producing, on average,19.73 tonnes of vegetable matter (half of the average 39.46 tonnes/ha), 124 kg manure N isrequired, or 23619.05 kg manure16. The total number of cows required to produce this levelof manure is 3.66 cows, producing in excess of 70 tonnes of manure. The total amount offeed required by 3.66 cows is 30.68 tonnes of feed. Hence, if an dairy feed production isassumed to be 10.75 tonnes of feed, on average 19.94 tonnes of feed should be purchased onthe exogenous feed market. These calibrations are based on a one dairy producer, onevegetable producer model.16 This value of 124 kg manure N (or 23619.05 kg manure) was calculated by dividing intwo the level of manure nitrogen required for a full hectare of vegetable production.77CHAPTER FIVEEMPIRICAL RESULTSThe focus of this chapter is to outline the empirical results from all the simulations ofthe model described in Chapter 3. These simulations were run using the solver componentof the spreadsheet package called EXCEL and incorporate the values of the model’sparameters that were explored and discussed in Chapter 4.5.1 Empirical Results from Base Case ModelThe base case scenario does not involve the use of economic instruments to decrease thelevel of social damage stemming from nitrate pollution of ground and surface water. Theresults from this simulation are presented in Table 5.1, which displays the amount of fertilizerdemanded, both inorganic and organic, by each producer, in addition to the values of theother choice variables and prices.As previously mentioned, the vegetable producer must decide whether to purchaseinorganic fertilizer or manure. This decision will depend on the parameter values of the CBSproduction function and the relative prices of both fertilizer inputs. The vegetable producerdemands 19347.17 kg of manure and 293.14 kg of inorganic fertilizer. These are equivalentto 101.57 kg of manure N and 146.57 kg of inorganic N’7. Although the relative factorshare, cc, associated with inorganic fertilizer is greater than that associated with organicfertilizer, the relative price difference between manure (i.e., the market price, W,, plus the17 These values were determined by converting the levels of inorganic fertilizer and manureinto levels of actual nitrogen, using the conversion factors described in Chapter 4.78transportation cost, -u) and inorganic fertilizer may also be affecting the overall levels ofdemand for these variables. The price of inorganic fertilizer, WI, ($O.3691kg, or $0.738/kgof mineral nitrogen) is greater than the relative price of manure, W, facing the vegetableproducer ($0.003317-i-’t=$0.004977/kg of manure, or $O.948 per kg of manure nitrogen).Table 5.1 Summary of Base Case Model SimulationVARIABLE VARIABLE DESCRIPTION LEVELVM quantity of manure demanded by vegetable producer 19347.17(kg)VI quantity of inorganic fertilizer demanded by vegetable 293.14producer_(kg)DM quantity of manure utilized by dairy producer (kg) 53420.59DI quantity of inorganic fertilizer demanded by dairy 431.78producer (kg)Oj quantity of feed purchased by dairy producer (T) 20.48MSOld quantity of manure sold by the dairy producer (kg) 19347.17M quantity of manure demanded by the composter (kg) 0W manure price of dairy producer ($/kg) 0.003317WMV manure price of vegetable producer ($Ikg) 0.003317WMC manure price of composter ($/kg) 0.0033 17W1 inorganic fertilizer price ($/kg) 0.369The dairy producer uses 53420.49 kg of manure and 431.78 kg of inorganic fertilizer inhis feed production. These are equivalent to 280.46 kg of manure N and 215.89 kg ofmineral nitrogen, respectively.’8 As explained earlier, these inputs have different relativefactor shares in the CBS feed production function. Therefore, this fact, coupled with the18 These values were determined by converting the levels of inorganic fertilizer and manureinto levels of actual nitrogen, using the conversion factors described in Chapter 4.79differences in their associated prices ($O.0033 17/kg manure or $O.6321kg manure N and$0.369/kg inorganic fertilizer or $0.738/kg mineral N) may offer an explanation as to whythe level of manure consumption that of inorganic fertilizer. The price of inorganic fertilizer,determined through the exogenous inorganic fertilizer market, is 1.17 times greater than themanure market price.The dairy producer purchases 20.48 tonnes of feed through the feed market. Hence, heproduces approximately 10.2 tonnes of feed to meet the total feed requirement of 8.395tonnes per cow. As mentioned in Chapter 4, the model is calibrated for 3.66 cows.No manure is sold to the composter. When the composter’s manure price (WMC) isgreater than the composter’s choke price (CHK), which is the case here, the composter willdemand no manure. The total level of manure sold to the vegetable producer and compostermust equal the amount of manure sold by the dairy producer, as is shown in equation (3.17).This condition holds within this model simulation, proving that all agents are linked throughthe manure market. The second market clearing condition, shown in equation (3.18), is thatthe price of manure which is received by the dairy producer (W) must equal the price ofmanure faced by both the vegetable producer (WMV) and the composter (WMC). These pricesshown to be equal, at $0.0033 17/kg manure, which demonstrates that this market conditionalso holds.As no economic instruments are included in this simulation, this model is considered tobe the base case scenario. The level of input demands shown in Table 5.1 are in accordancewith the real world production scenarios discussed in Chapter 4. Hence, this model will80provide the basis for comparisons with those model simulations which do include economicinstruments.5.2 Empirical Results from the Manure Tax ModelThe objective of this simulation was to determine the effects of a manure tax on theoverall manure market model, and to assess the effect on social damage. As theimplementation of such a tax increases the vegetable producer’s relative price of manure, thepreviously optimal levels of his/her fertilizer demands will change, as will the price ofmanure. Furthermore, the previously optimal decisions made by both the dairy producer andcomposter will be affected by these changes. Table 5.2 summarizes the levels of the differentchoice variables that result from the introduction of a 10 percent manure tax into theobjective function of the vegetable producer, as is shown in equations (3.19) and (3.20).81Table 5.2 Summary of Variables Under Manure Tax ScenarioAs a manure tax of 10 percent increases the vegetable producer’s effective manure price,the amount of manure demanded by the vegetable producer decreases relative to the base casescenario, from 19347.17 to 18261.91 kg of manure. His/her demand for inorganic fertilizerdecreases slightly from 293.14 to 292.72 kg, although the price of inorganic fertilizer remainsunchanged at $0.369/kg, or $0.738/kg of mineral nitrogen. The vegetable producer’s priceof manure, which is essentially the market price for manure plus the manure transportationcost and the value of the tax [$0.00317 (1-i-T-i-0.1)=$0.005307/kg of manure, or $1.01 1/kg ofmanure N], exceed the exogenously determined inorganic fertilizer price. Both output andVARIABLE VARIABLE DESCRIPTION LEVELTAX manure tax (%) 0.1VM manure demand of vegetable producer (kg) 18261.91VI inorganic fertilizer demand of vegetable producer (kg) 292.72DM manure utilized by dairy producer (kg) 54505.85DI inorganic fertilizer demand of dairy producer (kg) 433.82Q quantity of feed purchased by the dairy producer 20.43(tonnes)MSOId quantity of manure sold by the dairy producer (kg) 18261.91M manure demand of composter (kg) 0W price of manure received by dairy producer ($/kg) 0.003271WMV price of manure faced by vegetable producer ($flcg) 0.003271WMV + TAX after-tax price of manure faced by vegetable producer 0.003598($/kg)WMC price of manure faced by composter ($/kg) 0.00327 1WI price of inorganic fertilizer ($/kg) 0.36982price/substitution effects are present in this scenario as is seen through the changes in therelative demands. The higher manure price causes the level of manure demanded by thevegetable producer (VM) to decrease. However, through an output effect, the amount ofinorganic fertilizer demanded (VI) decreases only slightly, since its associated price remainsunchanged.The quantity of manure used in feed production (DM) increases (from 53420.59 to54505.85 kg), as does the level of inorganic fertilizer (DI) (from 431.78 to 433.82 kg). Theamount of feed purchased by the dairy producer (Q) decreases from 20.48 to 20.43 tonnes,as the quantity of feed produced increases by 0.05 tonnes. The increase in feed productionis attributed to both the increased use of inputs and a decrease in the price of manure, from$0.0033 17/kg to $0.00327 1/kg (or from $0.63 18/kg to $O.623/kg of manure N). As the priceof manure has dropped, the revenue potentials of the dairy producer have decreased, resultingin increased manure availability for both the dairy producer and composter.The quantity of manure demanded by the composter (M) is directly determined by theprice of manure facing the composter (WMC), as shown in equation (3.16). Since the priceof manure ($0.003217/kg) exceeds the composter’s choke price ($0.003 16/kg), the demandfor manure by the composter remains steady at 0. The quantity of manure sold by the dairyproducer, MSO1d, equals the sum of the quantities of manure demanded by the vegetableproducer (VM) and the composter (M), revealing that the market linkage between these threeagents is effective. The prices facing the composter and the vegetable producer (WMC andW, respectively) equal the manure price received by the dairy producer (W), exposingthe effectiveness of the second market clearing condition.83As the manure tax rate changes, the levels of the model’s choice variables are altered.Numerous tax rate change simulations were undertaken using different levels of taxes and thefollowing conclusions are made based on their results. (See Appendix 5A)As the tax rate increases:• the demand for manure by the vegetable producer (VM) decreases, as does the demandfor inorganic fertffizer (VI);• the overall manure market price (W, WMV, WMC) decreases, while the effective manureprice increases for vegetable producers by the amount of the transportation costs plus themanure tax;• the dairy producer’s demands for inorganic fertilizer (DI) and manure (DM) increase,although the demand for inorganic fertilizer increases at a substantially slower rate;• the level of purchased feed (Q) decreases and the amount of feed produced increases;• the decreased manure market price creates a wedge between the composter’s choke price(CHK) and the manure market price (WMC).• the composter begins demanding manure at a tax rate of approximately 45 percent, andthis demand increases with subsequent increases in the tax rate; and• the total quantity of manure sold by the dairy producer (M) decreases since thequantity demanded by the vegetable producer decreases at a faster rate than the quantityof manure demanded by the composter increases.As the tax rate decreases:• the levels of the model’s choice variable begin to return to their levels associated withthe base case scenario described in Section 5.1;• the quantities ofmanure and inorganic fertilizer demanded by the vegetable producer (VIand VM, respectively) increase, while the price of manure actually increases; and• the composter’s demand for manure (M) decreases to zero, and the level of manure andinorganic fertilizer demanded by the dairy producer (DM and DI), as well as the amountof feed produced, also decrease towards their base levels.845.3 Empirical Results from Inorganic Tax ModelThe objective of this model simulation was to determine the effects of an inorganicfertilizer tax on the overall manure market model, as described in equations (3.21) through(3.24) of section 3.3.2, and to qualitatively analyze the associated repercussions to socialdamage. The implementation of such a tax increases the both the dairy and vegetableproducers relative inorganic fertilizer price (WI), causing changes to the previously optimalfertilizer demands. Furthermore, the manure price is affected by these demand changes.Table 5.3 summarizes the levels of the different choice variables that result from theintroduction of a 5 percent inorganic fertilizer tax into the objective functions of the dairy andvegetable producers.85Table 5.3 Summary of Variables Under Inorganic Fertilizer Tax ScenarioVARIABLE VARIABLE DESCRIPTION LEVELINOTAX inorganic fertilizer tax (%) 0.05VM manure demand of vegetable producer (kg) 19499.42VI inorganic fertilizer demand of vegetable producer (kg) 277.31DM manure utilized by dairy producer (kg) 53268.34DI inorganic fertilizer demand of dairy producer (kg) 404.11Q quantity of feed purchased by the dairy producer 20.6(tonnes)MSO1d quantity of manure sold by the dairy producer (kg) 19499.42M manure demand of composter (kg) 0W price of manure received by dairy producer ($Ikg) 0.003289W, price of manure faced by vegetable producer ($/kg) 0.003289WMC price of manure faced by composter ($/kg) 0.003289WI price of inorganic fertilizer ($/kg) 0.369WI(1+inotax) after-tax price of inorganic fertilizer ($/kg) 0.387The 5 percent inorganic fertilizer increases both the dairy and vegetable producers’effective inorganic fertilizer price (WI) from $0.369/kg to $0.387/kg. Hence, the level ofinorganic fertilizer demands of each of these producers decreases, as is known from demandtheory. The vegetable producer, who formerly demanded 293.14 kg under the base casescenario, now demands 277.31 kg of inorganic fertilizer (VI). The dairy producer’s inorganicfertilizer demand (DI) decreases from 431.78 kg to 404.11 kg. The quantity of manuredemanded by the vegetable producer (VM) increases slightly from 19347.17 to 19499.42 kg,while that of the dairy producer (DM) decreases relative to the base case scenario, from53420.59 to 53268.34 kg of manure. These modest changes in manure demand are related86to the slight manure price decrease, from $O.0033 17/kg to $O.003289/kg. These changes inthe relative demands exhibit that both output and price! substitution effects are present withinthis scenario.As the total quantity of fertilizer (inorganic and manure) used in feed productiondecreases (from 496.35 to 481.72 kg of actual nitrogen)’9,resulting in an increased level offeed purchased by the daiiy producer (Q) from 20.48 to 20.6 tonnes. The decrease in feedproduction is attributed both to the decreased use of inputs and to an increase in the inorganicfertilizer price resulting from the tax.The quantity of manure demanded by the composter (M) is directly determined by theprice of manure facing the composter (WMC) as shown in equation (3.16). Since the price ofmanure ($0.003289/kg) exceeds the composter’s choke price ($0.003 16/kg), the demand formanure by the composter remains steady at 0. The first of the two market clearingconditions, that the quantity of manure sold by the dairy producer, M$OM, equals the sum ofthe quantities of manure demanded by the vegetable producer (VM) and the composter (Mg),is effective. The prices facing the composter and the vegetable producer (WMC and W,,,respectively) equal the manure price received by the dairy producer (W,), exposing theeffectiveness of the second market clearing condition.As the inorganic fertilizer tax rate fluctuates, the levels of the model’s choice variablesare altered. Numerous tax rate change simulations were undertaken using different percentage19 This value was determined by converting the levels of inorganic nitrogen and manure intolevels of actual nitrogen, using the conversion factors described in Chapter 4.87inorganic fertilizer taxes and the following conclusions are made based on their results. (SeeAppendix 5B)As the inorganic fertilizer tax rate increases:• the effective inorganic market price (WT(l+inotax)) faced by both the vegetable and dairyproducers increases;• the demand for manure by the vegetable producer (VM) increases, although his/herdemand for inorganic fertilizer (VI) decreases;• the dairy producer’s demand for inorganic fertilizer (DI) and manure (DM) decrease,although the demand for inorganic fertilizer decreases at a faster rate;• the level of purchased feed increases and the amount of feed produced decreases, as lessnitrogen inputs are used in the production process;• although the manure market price (WMC, W, W,) decreases, it continues to exceedthe composter’s choke price (CHK) resulting in zero demand by the composter (M);2°and• the total quantity of manure sold by the dairy producer (MSO1d) increases since thequantity demanded by the vegetable producer increases.As the inorganic fertilizer tax rate decreases:• the levels of the model’s choice variable begin to return to their levels associated withthe base case scenario described in Section 5.1.The main effect of the implementation of a percentage inorganic fertilizer tax is thedecreased inorganic fertilizer demands of both the vegetable and dairy producers (VT and DI,respectively). The level of manure demanded by the vegetable producer (VM) increases,20 It should be noted that tax rates over inotax = 30% were not estimated. For tax ratesabove this level, the market price of manure decreased below the level of the choke price,inducing the composter to purchase manure. However, as a fixed quantity of manure is available,the level of manure produced could not satisfy the demands of all producers. Hence, at inorganicfertilizer tax rates above 30 percent, the model is insolvable, If other manure sources wereavailable, the composter’s demand could be met.88while that of the dairy producer decreases (DM). The overall level of mineral nitrogen usedin vegetable production decreases from 248.14 kg to 241.02 kg21, which may cause somedecreased level of social damage stemming from nitrate pollution. However, this will bedetermined by the physical attributes of the soils. If the nitrate leaching levels of the soilsare known to be high, it is easier to predict whether the level of ground and surface waterpollution would increase or decrease with the implementation of such a tax. The level ofactual nitrogen applied by the dairy producer, as mentioned, also decreases. The conclusionsin terms of the actual changes in social damage of this model are difficult to determine.While it is true that the levels of overall nitrogen applications decrease, the effects of sucha decrease on nitrate pollution would be dependent on the physical attributes of the land baseof each individual operation. As is the case with the manure tax, there may be an optimallevel at which a tax rate should be set in order for the level of damage resulting from nitratecontamination to decrease. The discovery of such a tax rate would require pre-specifiedknowledge of an actual damage function, which, as mentioned, is unavailable.5.4 Empirical Results from the Subsidy ModelThe objective of this simulation is to determine the effects of a fixed composting subsidyrate on the overall manure market model and the ensuing demands of each producer. Table5.4 summarizes the results of this optimization when a 10 percent composting subsidy isprovided by the government to the composter.21 These values were determined by converting the levels of inorganic fertilizer and manureinto levels of actual nitrogen, using the conversion factors described in Chapter 4.89Table 5.4 Summary of Variables Under The Composting Subsidy ScenarioThe establishment of a fixed level composting subsidy decreases the effective manureprice faced by the composter (WMC) by the amount of the subsidy (S). The market price ofmanure less the subsidy is $0.0030519/kg, which is lower than the composter’s choke priceof $0.003 16/kg. Therefore, the quantity of manure by the composter (M) increases from 0kg (in the base case scenario) to 2165.07 kg with the provision of a 10 percent compostingsubsidy. The composter’s demand increases with increasing levels of the compostingsubsidy.2222 Refer to Appendix 5C of this chapter for tables showing these changes in composterdemands.VARIABLE VARIABLE DESCRIPTION LEVELS composting subsidy (%) 0.1VM manure demand of vegetable producer (kg) 18865.94VI inorganic fertilizer demand of vegetable producer (kg) 292.97DM manure utilized by dairy producer (kg) 51736.75DI inorganic fertilizer demand of dairy producer (kg) 428.57Q quantity of feed purchased by the dairy producer 20.56(tonnes)M quantity of manure sold by the dairy producer (kg) 21021.01M manure demand of composter (kg) 2165.07W price of manure received by dairy producer ($Ikg) 0.00339 1W price of manure faced by vegetable producer ($/kg) 0.00339 1WMC price of manure faced by composter ($/kg) 0.00339 1WMC - S after-subsidy price of manure faced by composter ($/kg) 0.003052WI price of inorganic fertilizer ($/kg) 0.36990The inclusion of a composting subsidy variable increases the aggregated demand formanure by the market participants. Hence, the manure market price (W, W, and WMC)increases from $0.0033 17/kg of manure, in the base case, to $0.0033911kg. This price changeinduces the vegetable producer’s manure demand (VM) to decrease from 19347.17 kg (in thebase case scenario) to 18865.94 kg. The level of inorganic nitrogen (Vi) also decreases, butto a lesser extent (from 293.14 to 292.97 kg), as the inorganic fertilizer price remainsunchanged. The quantity of manure used in feed production (DM) decreases, from 53420.59to 51736.75 kg, as does the level of inorganic fertilizer (DI), from 431.78 to 428.57 kg. Therelative changes in the demands for inorganic fertilizer by both the vegetable and dairyproducers are smaller than those associated with changes in the demands for manure, due tothe exogenously determined, fixed price of inorganic fertilizer.The total amount of feed purchased remains relatively unchanged, increasing slightlyfrom 20.48 to 20.56 tonnes. Therefore, the associated quantity of feed produced also remainsrelatively stable. These minute changes result from the structure of the CBS feed productionfunction and indicate the effects of relative price changes on the quantity of feed produced.The price of purchased feed is determined through an exogenous, perfectly competitivemarket, where the dairy producer cannot effect the level of the overall price.As the fixed level of the composting subsidy is altered, the levels of the model’s choicevariables also change. Numerous simulations were undertaken using different subsidy levelsand the following conclusions are made based on their results. (See Appendix SC)91As the subsidy level increases:• the quantities of manure and inorganic fertilizer demanded (VM and VI) by the vegetableproducer decrease;• the vegetable producer’s inorganic fertilizer demand (VI) decreases at a slower rate thanthe manure fertilizer demand (VM), mainly due to the inability of the vegetable producerto influence the inorganic fertilizer price level;• the amount of manure used by the dairy producer in feed production (DM) decreases asdoes the quantity of inorganic fertilizer (DI);• the inflexibility of the inorganic fertilizer price (WI) causes the rate of change in dairyproducer’s inorganic fertilizer demand (DI) to be slower than that of his/her manuredemand (DM);• the quantity of feed purchased by the dairy producer (Q) increases slightly, as the levelof feed production decreases since less inputs are used in the feed production process;• the quantity of manure sold to the composter increases, and at a fairly rapid rate;• the composting subsidy effectively decreases the composter’s net manure price (WMC -S), thereby increasing the level of his/her demand (Me);• the overall manure market price (W, W, WMC) increases with increased subsidyvalues, as the increased demand of the composter effects the price level more than thedecreased demands of the vegetable and dairy producers; and• the increased level of composter manure demand (M) results in less manure beingavailable both the dairy and vegetable producers.5.5 Empirical Results from Quantitative Manure Application Limit ModelThe objective of this model is to determine the changes manure market due to theimposition of a manure application limit on the dairy producer. Different application limitswere assigned at random. Table 5.5 displays the results from a limit of 51000 kg of manure;appendix 5D of this chapter contains tables displaying the results from application limits of40000 kg and 30000 kg.92Table 5.5 Summary of Variables Under Manure Application Limit (DM = 51000)VARIABLE VARIABLE DESCRIPTION LEVELDM manure application limit (kg) 51000VM manure demand of vegetable producer (kg) 20799.44VI inorganic fertilizer demand of vegetable producer (kg) 293.67DI inorganic fertilizer demand of dairy producer (kg) 427.18Q quantity of feed purchased by the dairy producer 20.59(tonnes)‘so1d quantity of manure sold by the dairy producer (kg) 21767.76M manure demand of composter (kg) 968.32W price of manure received by dairy producer ($Ikg) 0.003113W price of manure faced by vegetable producer ($/kg) 0.003113WMC price of manure faced by composter ($Ikg) 0.003113WI price of inorganic fertilizer ($Ikg) 0.369In order for manure application limits to be effective, they must limit the quantity ofmanure applied to the land to be less than the quantity of manure demanded by the dairyproducer (DM) under the base case scenario. In Table 5.5 above, the manure nitrogenapplication limit is 51000 kg, which is less than the 53420.59 kg of manure demanded by thedairy producer under the base case scenario. As a result of this limit, there is an increasedquantity of manure on the market. This causes the price of manure (W, W, and WMC)to be depressed at $0.003 11 3/kg, which is lower than the price of $0.0033 17/kg found in thebase case. Since the market price of manure is lower, both the vegetable producer andcomposter increase their associated levels of demand, from 19347.17 kg and 0 kg(respectively in the base case) to 20799.44 kg and 968.32 kg. The increased level of demandby the composter stems directly from the choke price (CHIC) exceeding the manure market93price (CHK = $0.003 16> $0.003 113 = WMC). As the inorganic fertilizer price (WI) remainsunchanged at $0.369/kg, the quantity of inorganic fertilizer demanded by the vegetableproducer (VI) increases only very slightly (from 293.14 to 293.67 kg), while the leveldemanded by the dairy producer (DI) decreases (from 431.78 to 427.18 kg). This decrease,coupled with the imposition of the manure application limit, results in an increase in thequantity of feed purchased (Q) by the dairy producer, from 20.48 to 20.59 tonnes.As the manure application limit is altered, the levels of the model’s choice variableschange. As mentioned, simulations were undertaken using different application limits andthe following conclusions are made based on their results. (See Appendix 5D)As the application limit increases (or the amount applied to the land decreases):• the quantities of manure and inorganic fertilizer demanded (VM and VI) by the vegetableproducer increase;• the quantity of inorganic fertilizer demanded by the dairy producer (DI) decreases as theamount of manure used by the dairy producer in feed production (DM) is restricted;• the inflexibility of the inorganic fertilizer price (WI) causes the rate of change in boththe vegetable and dairy producers inorganic fertilizer demands (VI and DI) to be slowerthan those of their manure demand (VM);• the quantity of feed purchased by the dairy producer (Q) increases slightly, as the levelof feed production decreases since less inputs are used in the feed production process;• the overall manure market prices (W, WMV, and WMC) decrease with the manureapplication limits, as more manure is available on the market.• the manure application limit forces more manure onto the market, and, coupled with thedecrease in WMC, effectively increasing the level of his/her demand (M); and• the quantity of manure sold to the composter (M) increases, and at a fairly rapid rate.945.6 Empirical Results from Combined Manure Tax and Composting SubsidyThe objective of this model was to determine the levels of the manure tax andcomposting subsidy rates which could be imposed for the tax revenue to finance thecomposting subsidy, making both financially, and therein politically, feasible. When differenttax and subsidy rates are fixed simultaneously, the production decisions and demands of allproducers are effected. The tabular presentation of the results from these simulation arefound in Appendix 5E of this chapter.The imposition of a manure tax has been shown, in section 5.2, to influence the levelsof all the choice variables found in the manure market model. It was concluded that the maineffect of such a tax was to decrease the quantity of manure transferred between the dairy andvegetable operations. However, with the imposition of a composting subsidy, the overalleffects of such a tax are diminished. The composting subsidy, indirectly, increases inefficiency in the presence of a manure tax. The manure tax discourages the vegetableproducer from purchasing manure, thereby forcing more manure onto the market andsuppressing the market price. The level of manure demanded by the composter, as shownin section 3.2.3, is completely dependent on the manure market price. Since the compostingsubsidy induces the composter to purchase manure, and the manure tax simply results in adecreased level of manure transfer between the vegetable and dairy producers, it can beconcluded that the dairy producer sells his excess manure to the composter, providing revenuegains.As the level of manure applied to the land by both the vegetable and dairy producersdecreases (refer to the base case scenario), and the participation of the composter in the95manure market increases, it is concluded that the overall level of social damage woulddecrease. The total quantities of nitrogen applied to the land decreases, thereby indicatingthat the potential for nitrate contamination of water would be somewhat thwarted by the jointimposition of a manure tax and composting subsidy.As mentioned, in order for a subsidy to be considered feasible, the financial backing mustbe readily available. By imposing tax-subsidy combinations, such as those shown inappendix SE, the tax revenue received could adequately cover the financial needs associatedwith the composting subsidy, in addition to other transaction and set-up costs incurred.96CHAPTER FIVE : APPENDIX 5ATable 5A.1 Summary of Variables Under Manure Tax Scenario (tax = 0.25)VARIABLE VARIABLE DESCRIPTION LEVELTAX manure tax (%) 0.25VM manure demand of vegetable producer (kg) 16829.23VI inorganic fertilizer demand of vegetable producer (kg) 292.14DM manure utilized by dairy producer (kg) 55938.53DI inorganic fertilizer demand of dairy producer (kg) 436.46Q quantity of feed purchased by the dairy producer 20.37(tonnes)M quantity of manure sold by the dairy producer (kg) 16829.23M manure demand of composter (kg) 0W price of manure received by dairy producer ($/kg) 0.003213W price of manure faced by vegetable producer ($/kg) 0.0032 13WMV - TAX after-tax price of manure faced by vegetable producer 0.004016($/kg)WMC price of manure faced by composter ($/kg) 0.003213WI price of inorganic fertilizer ($/kg) 0.36997Table 5A.2 Summary of Variables Under Manure Tax Scenario (tax = 0.45)VARIABLE VARIABLE DESCRIPTION LEVELTAX manure tax (%) 0.45VM manure demand of vegetable producer (kg) 15194.21VT inorganic fertilizer demand of vegetable producer (kg) 291.41DM manure utilized by dairy producer (kg) 57458.33DI inorganic fertilizer demand of dairy producer (kg) 439.21Q quantity of feed purchased by the dairy producer 20.31(tonnes)MSOld quantity of manure sold by the dairy producer (kg) 15309.43M manure demand of composter (kg) 115.22W price of manure received by dairy producer ($/kg) 0.003154W price of manure faced by vegetable producer ($Ikg) 0.003154WMV - TAX after-tax price of manure faced by vegetable producer 0.004573($/kg)WMC price of manure faced by composter ($/kg) 0.003154WI price of inorganic fertilizer ($/kg) 0.36998Table 5A.3 Summary of Variables Under Manure Tax Scenario (tax = 0.55)VARIABLE VARIABLE DESCRIPTION LEVELTAX manure tax (%) 0.55VM manure demand of vegetable producer (kg) 14437.75VT inorganic fertilizer demand of vegetable producer (kg) 291.05DM manure utilized by dairy producer (kg) 57890.27DI inorganic fertilizer demand of dairy producer (kg) 439.98Q quantity of feed purchased by the dairy producer 20.29(tonnes)MSOld quantity of manure sold by the dairy producer (kg) 14877.49M manure demand of composter (kg) 439.74W price of manure received by dairy producer ($/kg) 0.003138W price of manure faced by vegetable producer ($/kg) 0.003138WMV - TAX after-tax price of manure faced by vegetable producer 0.004864($/kg)WMC price of manure faced by composter ($/kg) 0.003 138WI price of inorganic fertilizer ($/kg) 0.36999Table 5A.4 Summary of Variables Under Manure Tax Scenario (tax = 0.7)VARIABLE VARIABLE DESCRIPTION LEVELTAX manure tax 0.7VM manure demand of vegetable producer (kg) 13427.13VT inorganic fertilizer demand of vegetable producer (kg) 290.55DM manure utilized by dairy producer (kg) 58471.03DI inorganic fertilizer demand of dairy producer (kg) 441.02Q quantity of feed purchased by the dairy producer 20.26(tonnes)MSOld quantity of manure sold by the dairy producer (kg) 14296.73M manure demand of composter (kg) 733.19W price of manure received by dairy producer ($/kg) 0.003 123W price of manure faced by vegetable producer ($/kg) 0.003123W - TAX after-tax price of manure faced by vegetable producer 0.005309($/kg)WMC price of manure faced by composter ($/kg) 0.003 123WI price of inorganic fertilizer ($/kg) 0.369100Table 5A.5 Summary of Variables Under Manure Tax Scenario (tax = 0.9)VARIABLE VARIABLE DESCRIPTION LEVELTAX manure tax 0.9VM manure demand of vegetable producer (kg) 12270.14VT inorganic fertilizer demand of vegetable producer (kg) 289.92DM manure utilized by dairy producer (kg) 59141.07DI inorganic fertilizer demand of dairy producer (kg) 442.2C quantity of feed purchased by the dairy producer 20.23(tonnes)MSOld quantity of manure sold by the dairy producer (kg) 13626.69M manure demand of composter (kg) 1356.55W price of manure received by dairy producer ($/kg) 0.003092W price of manure faced by vegetable producer ($/kg) 0.003092WMV - TAX after-tax price of manure faced by vegetable producer 0.005875($/kg)WMC price of manure faced by composter ($/kg) 0.003092WI price of inorganic fertilizer ($/kg) 0.369101CHAPTER FIVE : APPENDIX 5BTable 5B.1 Summary of Variables with Inorganic Fertilizer Tax Scenario (inotax = 0.1)VARIABLE VARIABLE DESCRIPTION LEVELINOTAX inorganic fertilizer tax (%) 0.1VM manure demand of vegetable producer (kg) 19644.5VI inorganic fertilizer demand of vegetable producer (kg) 263.01DM manure utilized by dairy producer (kg) 53123.26DI inorganic fertilizer demand of dairy producer (kg) 379.41Q quantity of feed purchased by the dairy producer 20.71(tonnes)M quantity of manure sold by the dairy producer (kg) 19644.5M manure demand of composter (kg) 0W price of manure received by dairy producer ($/kg) 0.003264W price of manure faced by vegetable producer ($Ikg) 0.003264WMC price of manure faced by composter ($Ikg) 0.003264WI price of inorganic fertilizer ($/kg) 0.369WT(1-i-inotax) after-tax price of inorganic fertilizer ($Ikg) 0.4059102Table 5B.2 Summary of Variables with Inorganic Fertilizer Tax Scenario (inotax = 0.2)VARIABLE VARIABLE DESCRIPTION LEVELINOTAX inorganic fertilizer tax (%) 0.2VM manure demand of vegetable producer (kg) 19915.36VI inorganic fertilizer demand of vegetable producer (kg) 238.22DM manure utilized by dairy producer (kg) 52852.4DI inorganic fertilizer demand of dairy producer (kg) 337.25Q quantity of feed purchased by the dairy producer 20.92(tonnes)MSOld quantity of manure sold by the dairy producer (kg) 19915.36M manure demand of composter (kg) 0W price of manure received by dairy producer ($Ikg) 0.003217W price of manure faced by vegetable producer ($/kg) 0.0032 17WMC price of manure faced by composter ($/kg) 0.003217WI price of inorganic fertilizer ($/kg) 0.369WI(1-i-inotax) after-tax price of inorganic fertilizer ($/kg) 0.4428103Table 5B.3 Summary of Variables with Inorganic Fertilizer Tax Scenario (inotax = 0.3)VARIABLE VARIABLE DESCRIPTION LEVELINOTAX inorganic fertilizer tax (%) 0.3VM manure demand of vegetable producer (kg) 20163.9VI inorganic fertilizer demand of vegetable producer (kg) 217.49DM manure utilized by dairy producer (kg) 52603.86DI inorganic fertilizer demand of dairy producer (kg) 302.68Q quantity of feed purchased by the dairy producer 21.11(tonnes)M0jd quantity of manure sold by the dairy producer (kg) 20163.9M manure demand of composter (kg) 0W price of manure received by dairy producer ($Ikg) 0.003 176WMV price of manure faced by vegetable producer ($Ikg) 0.003176WMC price of manure faced by composter ($/kg) 0.003 176WI price of inorganic fertilizer ($/kg) 0.369WI(1+inotax) after-tax price of inorganic fertilizer ($/kg) 0.4797104CHAPTER FIVE : APPENDIX 5CTable 5C.1 Summary of Variables Under Composting Subsidy (S=0.25)VARIABLE VARIABLE DESCRIPTION LEVELS composting subsidy (%) 0.25VM manure demand of vegetable producer (kg) 17412.19VT inorganic fertilizer demand of vegetable producer (kg) 292.38DM manure utilized by dairy producer (kg) 46727.39DI inorganic fertilizer demand of dairy producer (kg) 418.56Q quantity of feed purchased by the dairy producer 20.79(tonnes)M quantity of manure sold by the dairy producer (kg) 26040.37M manure demand of composter (kg) 8628.18W price of manure received by dairy producer ($/kg) 0.003638WMV price of manure faced by vegetable producer ($flcg) 0.003638WMC price of manure faced by composter ($/kg) 0.003638WMC + S after-subsidy price of manure faced by composter ($/kg) 0.002729WI price of inorganic fertilizer ($/kg) 0.369105Table 5C.2 Summary of Variables Under Composting Subsidy (S=0.5)VARIABLE VARIABLE DESCRIPTION LEVELS composting subsidy (%) 0.5VM manure demand of vegetable producer (kg) 14606.71VT inorganic fertilizer demand of vegetable producer (kg) 291.13DM manure utilized by dairy producer (kg) 37411DI inorganic fertilizer demand of dairy producer (kg) 397.77Q quantity of feed purchased by the dairy producer 21.28(tonnes)MSOld quantity of manure sold by the dairy producer (kg) 35356.76M manure demand of composter (kg) 20750.04W price of manure received by dairy producer ($Ikg) 0.004245W price of manure faced by vegetable producer ($/kg) 0.0(4245WMC price of manure faced by composter ($Ikg) 0.004245WMC + S after-subsidy price of manure faced by composter ($/kg) 0.002 123WI price of inorganic fertilizer ($Ikg) 0.369106Table 5C.3 Summary of Variables Under Composting Subsidy (S=0.7)VARIABLE VARIABLE DESCRIPTION LEVELS composting subsidy (%) 0.7VM manure demand of vegetable producer (kg) 11783.12VI inorganic fertilizer demand of vegetable producer (kg) 289.65DM manure utilized by dairy producer (kg) 28544.95DI inorganic fertilizer demand of dairy producer (kg) 374.31Q quantity of feed purchased by the dairy producer 21.84(tonnes)Msold quantity of manure sold by the dairy producer (kg) 44222.81M manure demand of composter (kg) 32439.69W price of manure received by dairy producer ($Ikg) 0.005127WMV price of manure faced by vegetable producer ($Ikg) 0.005 127WMC price of manure faced by composter ($/kg) 0.005127WMC + S after-subsidy price of manure faced by composter ($jlcg) 0.001538WI price of inorganic fertilizer ($/kg) 0.369107Table 5C.4 Summary of Variables Under Composting Subsidy (S=O.9)VARIABLE VARIABLE DESCRIPTION LEVELS composting subsidy (%) 0.9VM manure demand of vegetable producer (kg) 7698.84VI inorganic fertilizer demand of vegetable producer (kg) 286.81DM manure utilized by dairy producer (kg) 16775.36DI inorganic fertilizer demand of dairy producer (kg) 333.37Q quantity of feed purchased by the dairy producer 22.80(tonnes)MSO1d quantity of manure sold by the dairy producer (kg) 55992.4M manure demand of composter (kg) 48293.56W price of manure received by dairy producer ($/kg) 0.007453W price of manure faced by vegetable producer ($/kg) 0.007453WMC price of manure faced by composter ($Ikg) 0.007453WMC + S after-subsidy price of manure faced by composter ($/kg) 0.000745WI price of inorganic fertilizer ($/kg) 0.369108CHAPTER FIVE : APPENDIX 5DTable 5D.1 Summary of Variables Under Manure Application Limit (DM = 40000)VARIABLE VARIABLE DESCRIPTION LEVELDM manure application limit (kg) 40000VM manure demand of vegetable producer (kg) 24160.92VI inorganic fertilizer demand of vegetable producer (kg) 294.78DI inorganic fertilizer demand of dairy producer (kg) 403.86Q quantity of feed purchased by the dairy producer 21.14(tonnes)MSO1d quantity of manure sold by the dairy producer (kg) 32767.76M manure demand of composter (kg) 8606.84W price of manure received by dairy producer ($/kg) 0.002729W, price of manure faced by vegetable producer ($/kg) 0.002729WMC price of manure faced by composter ($/kg) 0.002729WI price of inorganic fertilizer ($/kg) 0.369109Table 5D.2 Summary of Variables Under Manure Application Limit (DM = 30000)VARIABLE VARIABLE DESCRIPTION LEVELDM manure utilized by dairy producer (kg) 30000VM manure demand of vegetable producer (kg) 27523.82VI inorganic fertilizer demand of vegetable producer (kg) 295.76DI inorganic fertilizer demand of dairy producer (kg) 380.52Q quantity of feed purchased by the dairy producer 21.69(tonnes)MSOld quantity of manure sold by the dairy producer (kg) 42767.76M manure demand of composter (kg) 15243.94W price of manure received by dairy producer ($Ikg) 0.002434WMV price of manure faced by vegetable producer ($/kg) 0.002434WMC price of manure faced by composter ($/kg) 0.002434WI - price of inorganic fertilizer ($ilcg) 0.369110CHAPTER FIVE : APPENDIX 5ETable 5E.1 Summary of Variables Under Combined Manure Tax and CompostingSubsidy Scenario #1VARIABLE VARIABLE DESCRIPTION LEVELTAX manure tax (%) 0.1S composting subsidy (%) 0.21VM manure demand of vegetable producer (kg) 16715.88VI inorganic fertilizer demand of vegetable producer (kg) 292.09DM manure utilized by dairy producer (kg) 48707.54DI inorganic fertilizer demand of dairy producer (kg) 422.6Q quantity of feed purchased by the dairy producer 20.7(tonnes)MSOld quantity of manure sold by the dairy producer (kg) 24060.23M manure demand of composter (kg) 7344.35W price of manure received by dairy producer ($/kg) 0.003535W price of manure faced by vegetable producer ($/kg) 0.003535WMV - TAX after-tax price of manure faced by vegetable producer 0.003889($Ikg)WMC price of manure faced by composter ($/kg) 0.003535WMC + S after-subsidy price of manure faced by composter ($Ikg) 0.002793WI price of inorganic fertilizer ($Ikg) 0.369Tax Revenue revenue gains from tax imposition ($Iha)23 5.91Subsidy Costs costs resulting from subsidy imposition ($/ha) 5.4523 This figure was calculated by the following:(Market Price) * (tax rate) * (vegetable producer’s manure demand)This figure was calculated by the following equation:(Market Price) * (subsidy rate) * (composter’s manure demand).111Table 5E.2 Summary of Variables Under Combined Manure Tax and CompostingSubsidy Scenario 2VARIABLE VARIABLE DESCRIPTION LEVELTAX manure tax (%) 0.15S composting subsidy (%) 0.252VM manure demand of vegetable producer (kg) 15831.4VT inorganic fertilizer demand of vegetable producer (kg) 291.7DM manure utilized by dairy producer (kg) 47527.29DI inorganic fertilizer demand of dairy producer (kg) 420.21Q quantity of feed purchased by the dairy producer 20.75(tonnes)MSO1d quantity of manure sold by the dairy producer (kg) 25240.47M manure demand of composter (kg) 9409.07W price of manure received by dairy producer ($/kg) 0.003596W price of manure faced by vegetable producer ($Ikg) 0.003596W - TAX after-tax price of manure faced by vegetable producer 0.004135($Ikg)WMC price of manure faced by composter ($/kg) 0.003596WMC + S after-subsidy price of manure faced by composter ($/kg) 0.00269WI price of inorganic fertilizer ($/kg) 0.369Tax Revenue revenue gains from tax imposition ($/ha)25 8.54Subsidy Costs costs resulting from subsidy imposition ($/ha)26 8.5325 This figure was calculated by the following:(Market Price) * (tax rate) * (vegetable producer’s manure demand)26 This figure was calculated by the following equation:(Market Price) * (subsidy rate) * (composter’s manure demand).112Table 5E.3 Summary of Variables Under Combined Manure Tax and CompostingSubsidy Scenario #3VARIABLE VARIABLE DESCRIPTION LEVELTAX manure tax (%) 0.3S composting subsidy (%) 0.32VIvI manure demand of vegetable producer (kg) 13927.35VI inorganic fertilizer demand of vegetable producer (kg) 290.8DM manure utilized by dairy producer (kg) 45805.85DI inorganic fertilizer demand of dairy producer (kg) 416.64Q quantity of feed purchased by the dairy producer 20.84(tonnes)MSOM quantity of manure sold by the dairy producer (kg) 26961.91M manure demand of composter (kg) 13034.55W price of manure received by dairy producer ($/kg) 0.003689WMV price of manure faced by vegetable producer ($/kg) 0.003689W - TAX after-tax price of manure faced by vegetable producer 0.004796($/kg)WMC price of manure faced by composter ($/kg) 0.003689WMC + S after-subsidy price of manure faced by composter ($Ikg) 0.002509WI price of inorganic fertilizer ($/kg) 0.369Tax Revenue revenue gains from tax imposition ($Iha)27 15.41Subsidy Costs costs resulting from subsidy imposition ($/ha) 15.3927 This figure was calculated by the following:(Market Price) * (tax rate) * (vegetable producer’s manure demand)28 This figure was calculated by the following equation:(Market Price) * (subsidy rate) * (composter’s manure demand).113CHAPTER SIXSUMMARY and CONCLUSIONSDue to the non-point source nature of agricultural water pollution in the Abbotsfordaquifer, it has been necessary to study the role of economic instruments which would affectthe direct costs and benefits pertaining to individuals utilizing any nitrogen-based product.The results is an effect on the level of both ground and surface water quality.Current measures, while addressing manure storage and application issues, do not addressthe two fundamental issues of: (i) there simply being too much nitrate present in the groundand surface water and (ii) the redistribution of manure to other areas where leaching and runoff are not prevalent. Hence, the use of any form of nitrogen fertilizer (i.e., inorganic ororganic) by any agricultural producers must be minimized so as to counteract this negativeexternality and promote sustainable management practices. Economic instruments are oneform of environmental policy that are effective in addressing these issues.6.1 MethodologyIn this thesis, a non-linear programming model was developed to create a market formanure, allowing for the transfer of manure between different agricultural operations.Current production data was used to estimate typical production activities of both a vegetableand a dairy producer. Each of these individuals decided whether to purchase inorganicfertilizer, from an exogenous inorganic fertilizer market, or organic fertilizer from the dairyproducer. The demand function of a composter was also determined and included in the114model; the level of composting activity is dependent on the manure market price level. Theobjective of this model was to minimize the overall level of nitrate damage and pollutionstemming from agricultural activities. The damage level was assessed, qualitatively, and wasfound to be dependant on the level of nitrogen-using activities undertaken by differentproducers and the associated physical properties of their land. The inclusion of economicinstruments caused alterations in optimal production decisions and the overall damage levelstenmiing from the model.Four different economic instruments were introduced into the model, first independentlyand then in tandem. These instruments include: a manure nitrogen tax faced by the vegetableproducer; an inorganic fertilizer tax faced by both the dairy and vegetable producers; acomposting subsidy; and a dairy manure application limit. Manure tax and compostingsubsidy combinations were then determined to identify the level of tax revenue required tofinance the composting subsidy, making both economically and politically feasible. Theeffects of these instruments on the production decisions of each agent was determined andcompared.6.2 Summary of ResultsThe initial model estimation, which allowed producers to operate without environmentalimproving economic instruments, helped determine the optimal level of manure and inorganicfertilizer demands. The price of manure was found to be greater than the composter’s chokeprice; hence, the composter did not participate in the manure market. This model, consideredas the base case scenario, provided for comparisons with the other model simulations.115The inclusion of a percentage manure tax in the objective function of the vegetableproducer changed the associated derived demand, resulting in an decreased demand formanure. Hence, the manure market price decreased as less manure was exchanged betweenthe dairy and vegetable producers. The manure price decreased to the point where itexceeded the choke price of the composter’s demand function, resulting in the composterparticipating in the market activities. The main effect of the inclusion of such a tax was thedecreased transfer of manure between the dairy and vegetable operations. Hence, dependingon the leaching and surface run-off susceptibilities of each operation, the level of socialdamage resulting from nitrate pollution may be altered. The establishment of an optimal taxrate would require knowledge of the level of the marginal external costs and marginal privatebenefits. As these are unavailable for this thesis, an optimal manure tax rate cannot bedetermined, however, the effects of the tax are assumed to be the same.A percentage composting subsidy is aimed at encouraging an environmentally positiveactivity, by initiating both an increase in the quantity of manure demanded by the composterand an associated decrease in those of the other producers. Hence, the level of nitratepollution should decrease as the levels of manure applied to the land by the dairy andvegetable producers decreases. The decreased application of manure to the land would alsominimize the possibility of the over-application of manure and, therein, decrease theoccurrence of surface manure run-off. Qualitatively, the level of social damage stemmingfrom nitrate pollution would decrease when a composting subsidy was provided by thegovernment.116The imposition of an inorganic fertilizer tax affected the production decisions of boththe vegetable and dairy producers. The result was an increased demand for manure fertilizer,and decreased demand for inorganic fertilizer. Changes in social damage that result from theimposition of such a tax are unclear. While the total level of nitrogen applied to the landdecreases, the changes in social damage are dependent on the physical attributes of the land.A manure application limit imposed on the dairy producer’s production activities forcesmore manure onto the market, causing the price of manure to decrease. The quantity ofmanure demanded by both the composter and vegetable producer increases. If the level ofleaching and manure surface run-off from the dairy producer’s land exceeds that of thevegetable producer’s, then the overall level of social damage would decrease. This decreasewould be augmented by the increased level of manure composted which occurs as strictermanure application limits are imposed. On the other hand, if the vegetable producer’s landbase was more susceptible to leaching, the increase damage from higher vegetable manureapplications would need to be compared with the decrease damage stemming from bothdecrease manure applications by the dairy producer and the increased level of composting todetermine the overall effects on damage.1176.3 Conclusions and Further ResearchAgricultural producers have been shown to be willing to change their managementpractices when their overall returns (revenues) can be increased. The key, however, is toaddress the use of economic instruments in agricultural policies and management practices.While agricultural extension programs can help provide producers with information pertainingto the costs and benefits associated with new management practices, producers need to beencouraged to accept them. Such programs, which address the external economies associatedwith good land management and stewardship, may need to be replaced or joined withprograms and policies involving economic instruments in order for less environmentaldegradation to occur.As mentioned, the WMA and Code are incapable of dealing with the problems of nitratepollution stemming from excessive fertilizer application and improper manure handlingpractices. The major problem is that too much manure is located in this area. Hence,measures are established to move the manure from these regions by providing producers withthe incentives to sell manure. By creating a manure market, the overall costs of keeping themanure are outweighed by the benefits (in the form of increased revenues) from selling themanure. The results of this manure market model indicate that economic instruments canaddress problems of nitrate pollution externalities efficiently. 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