AAE 142 Topic 4 Economics of Land and Water Resources 1st Sem AY 2023-24 PDF

AAE 142 COURSE NOTE TOPIC 4: ECONOMICS OF LAND AND WATER RESOURCES1 At the end of the chapter, the students should be able to: a. discuss the trends in the use of land and water resources, b. determine the conditions for efficient allocation of land and water resources, and...

AAE 142 COURSE NOTE TOPIC 4: ECONOMICS OF LAND AND WATER RESOURCES1 At the end of the chapter, the students should be able to: a. discuss the trends in the use of land and water resources, b. determine the conditions for efficient allocation of land and water resources, and c. discuss relevant issues associated with land and water resource use. 4.1 Land 1 This course note was prepared by Cenon D. Elca, Assistant Professor at the Department of Agricultural and Applied Economics, College of Economics and Management, University of the Philippines Los Baños for educational purposes only. Use of this material must be limited only for personal use of enrolled students of AAE 142. No part of this material may be reproduced, distributed, exhibited in any form or manner, quoted, or cited without the written consent of the author. 4-1 4-2 4-3 4-4 4-5  3 hypothetical alternative land uses  Wilderness is a large uncultivated tract of land left in its natural state  Zero represents the center of a particular place like a city, town or municipality, while C is the farthest point  Horizontal axis – represents increasing distance away from the center  Vertical axis – represents net benefits derived by society from allocating land to 3 alternative uses  3 downward sloping lines are bid rent functions – represents the relationship between distance to the center and the net benefits from each type of land use  Bid rent functions also expresses the maximum benefit to the society by a particular land use as a function of the distance from the center  All 3 functions are downward sloping since the cost of transporting goods and people lower the net benefits for more distant locations  Bid rent function of residential development is steeper than the other 2 land uses  This means that residential development provides the highest net benefit. Job creation and housing has higher value than activities in agriculture and wilderness  Between distance 0 and A, it makes sense to allocate land in residential development since the net benefits is higher compared to the net benefits from agriculture and wilderness  Between A and B, land should be devoted to agriculture  Between B and C, land should be allocated to wilderness 4-6  Intersection point of residential development and agriculture – point where residential development stops and beginning of agriculture  Intersection point of agriculture and wilderness – point where agriculture activities stop and beginning of preservation of wilderness 4-7 The y-axis represents output per worker or the average product (AP) or simply the ratio of output and input (e.g. cavans of palay over number of workers). The x-axis represents the number of workers or the level of labor input. Each point on the graph represents the AP of each unit of labor or each count of number of workers. For example, employing 10 workers on the 2 hectares of land will result to an output of 1,800 cavans of palay. Therefore, using 10 workers corresponds to an average product of 180. This 180 means that each worker can produce 180 cavans of rice. Increasing the number of workers to 11 will increase output to 1,900 cavans of rice, but AP decreased to 173. Each worker can now produce less cavans of rice or the AP of workers decreased. Land rent is a surplus or the return to land or profit of landowner as a result of using the land. Land rent, therefore, is the value of production less the cost of inputs, or simply total revenue minus total cost (TR-TC). Let’s assume that the price of labor (wage rate) and price of output are fixed and equal to one. Total revenue of using 10 workers is 180 (or 1,800 cavans x Php1/cavan, assuming the price of palay is constant and equal to 1). Total cost is 1,000 (or 10 workers x 10 cavans/worker). Therefore, land rent is equal to 800 cavans. For 11 workers, land 4-8 rent is also equal to 800 cavans. However, the AP of labor declines from 180 to 173 when the number of workers increased from 10 to 11. The marginal product is the change in output per unit change in input ( output/ input). For the 11th worker, the marginal product is (1,900- 1,800)/(11-10) = 100 cavans. Rule: if MP (100) < AP (173), then AP must be decreasing. Review: law of diminishing marginal returns - as additional units of a variable input (labor) is used in combination with one or more fixed inputs (land), MP will eventually decline. The landowner, as a rational producer, would want to maximize profit or land rent. The total approach (getting the difference of TR and TC) revealed two levels of number of workers (10 and 11) that maximizes land rent (800 cavans). Using the marginal approach, profit or land rent is maximize if MP = Price of input/Price of output. Since price of input is assumed to equal to one, then land rent is maximized if MP = price of input. And this condition is satisfied at 11 workers. Using 11 workers, MP is equal to (1,900-1,800)/(11-10) = 100, while price of input is fixed at 100. Using 11 workers, TR is 0 11 c d, TC is 0 11 b a, and land rent is a b c d. 4-9 This is just an extension of the previous model of one plot of land. The x-axis shows the total amount of labor available to the two plots. Movement from zero to the right increased the allocation of labor for Plot A, while movement from right to left increases labor allocation for Plot B. Since there are now two plots (A and B), each plot will have corresponding marginal products, MPA and MPB. Plot A has higher quality than Plot B. This is represented by the higher average product and marginal product of Plot A relative to Plot B at any given equal amount of labor. Review: The profit-maximizing input level is determined by the condition, marginal value product (MVP) is equal to price of input. The application of this condition in the two plots should satisfy the following: MVPA = wage, and MVPB = wage. Extending these two equations will result to MPA * PA = wage, and MPB * PB = wage. Since PA and PB are assumed as constant and equal to one, we will end up with the final conditions of MPA = wage, and MPB = wage. What if MPA > MPB, then there will be incentive for the landowner to increase allocation of labor to Plot A since Plot A is still more productive than Plot B until such time that MPA = MPB. The opposite condition of MPB > MPA will also happen. Therefore, rent is maximum if 4-10 MPA = MPB and both marginal products are equal to the wage rate. This rent-maximizing point is indicated as point X, where NA amount of labor will be allocated to Plot A and NB amount of labor will be allocated to Plot B. How do we apply the rent-maximizing condition involving several plots of land with different qualities? Given M number of plots where Plot A has the highest quality followed by Plot B and so on and so forth, each plot will have corresponding MPs, specifically MPA , MPb up to MPM. We start each new plot at a different vertical axis, indicated as dashed lines. Plots will be used (or allocated with labor) as long as the MP is at least greater than the wage (W). The last plot that will be used is Plot M. The rent-maximizing conditions for each plots are: NA amount of labor for Plot A, NB amount of labor for Plot B, and NC amount of labor for Plot C. The marginal plot (the least productive plot) is Plot M. Note that Plot M’s MP curve is not above the wage (W). This means that Plot M will have no rent for the landowner. The total returns to the plot are all paid to the workers. On the other hand, Plots A to C will earn rents since some segments of the MPs are above the wage (W). 4-11 Two types of property rights Private property – resource is owned by individuals and closed access to other individuals. Open access – no one owns the resource and can be accessed by all people. Assume that aside from a landowner privately owning (i.e. private property) a land resource, another type of property right is open access where there is no unique owner of the land. There’s also no government policy that would allocate labor. Open access is the case where anyone is free to use the resource (e.g. land) however he/she fit. Each worker is concerned only on what he/she can take from the land. Since there is no landowner that would maximize rent, the landowner’s rent is available to be shared among the workers. In open access, the first few workers who will work the land will earn wage above the market wage (W). This extra income of the first few workers would entice additional workers to work the land. This will then drive the wage downward up to the market wage (W). More people will be employed. However, these workers will receive the same wage (W). In the above figure, the rent-maximizing condition for private property is at NPP units of labor where the marginal product is equal to wage. For open access, the solution is at NOP units of labor where the average product is equal to wage. No laborer would want to work beyond NOP units of labor since this would imply that workers would receive lower wage than W. The end result is that open access with entry of new workers will result to excessive use of a variable input (i.e. labor) and excessive output. However, workers are no better off since they will receive the same wage (W). Also note that at NOP units of labor, land rent is zero. Thus, rent is said to be dissipated under open access. 4-12 4-13 4.2 Water 4-14 4-15 4-16 The demand curve for water in the urban areas (personal use) starts from left to right, while the demand curve for water in the rural areas (agricultural use) starts from right to left. Suppose that the price of water is zero, implying that water is free to use. The quantity demanded of water in the urban areas is 0Uo, while the quantity demanded of water in the rural areas is WTRo. Total demand for water, therefore, is 0Uo + WTRo. This is not a sustainable situation since the existing supply of water (0WT) is lower than the total demand for water (0Uo + WTRo). There must a means to efficient allocate the fixed supply of water to different users. Suppose that the price of water is equal to P*. The horizontal line P*P* is the supply curve or the marginal cost curve of water. It is perfectly elastic, implying that the water supplier can supply any amount of water but will receive the same price P*. An efficient water allocation is achieved where demand for both urban and rural users is equal to supply. This is indicated as point e in the graph corresponding to the intersection of the supply curve and 2 demand curves. At point e, urban users will demand 0W* amount of water, while rural users will demand WTW* amount of water. These demands will be fulfilled by 0WT total supply of water. 4-17 CS is the area under the demand curve, above the price. Buyers below P*, they will not buy or do not participate in the market, or they can adjust their purchase price to P*, purchasing 0W*. Buyers at P*, will purchase 0W*. Buyers above at P*, will definitely buy at P*, because they will pay lower prices. CS is can be represented as avoided expenses or expenditure savings for consumers that are willing to buy above P*. The efficient allocation of water corresponding to P* and W* leads to maximum societal welfare, as represented by the consumer’s surplus (CS). The CS of urban users is represented by area A+B, while the CS of rural users is area C. Total welfare in this case is area A+B+C. No other possible re-allocation of water is possible that can maximize welfare of consumers. 4-18 If we consider allocation W’, welfare of urban users will decrease to area A, while the welfare of rural users is unchanged. The net effect to society is a welfare loss of area B. In the real world, a perfectly competitive market may not be the ideal mechanism in allocating an essential good like water. The government or any private entity are most likely not able to operate at an efficient equilibrium where certain segments of society (e.g. poor people) cannot afford to pay for water. If water suppliers decide to operate in a perfectly competitive equilibrium, poor consumers may not be able to pay. In the above figure, the demand for water is differentiated by an aggregate demand (i.e. demand by all consumers) and demand by low-income groups represented as DL downward sloping curve. The equilibrium condition is at point A (intersection of aggregate demand and marginal cost or supply of water), where the price of water should be P* and total water consumption is W*. For low-income consumers, given a price P*, they are only willing to purchase 0WL amount of water, which implies very low consumption. This purchase of 0WL water consumption maybe insufficient to meet the basic needs of low-income consumers. 4-19 The purchase of 0WL water consumption maybe insufficient to meet the basic needs of low- income consumers. An option to solve this is for the supplier to lower the price from P* to PL* for all consumers. This would increase the water consumption of low-income consumers to 0WL* and aggregate water consumption. Another option is to implement a two-pricing schemes, where low-income consumers will pay at PL*, while the rest of the consumers will pay at P*. 4-20 Review Questions:  Discuss and differentiate the efficient allocation of land between an open access and private property right.  Discuss and differentiate the efficient allocation of water between an open access and private property right. 4-21 Assessment Tools: Exercise on the estimation of consumer’s surplus under alternative water pricing schemes. References: Hartwick, J. and N. Olewiler. (1998). The Economics of Natural Resource Use. Addison- Wesley. Tietenberg and Lewis. (2012). Environmental and Natural Resource Economics: 9th Edition. 4-22