[MUSIC PLAYING] This time we're going to talk about water pollution again. We've covered it in a previous segment. But we're going to look at in a different way. We're going to ask the question, how much does the possibility of water pollution resulting from use of an input affect the optimal decision-making about the level of that input that a farmer should be using? And we're going to use water pollution resulting from fertilizers as the example. So there are many examples around the world of fertilizers causing water pollution in nearby water bodies. And it's not hard to find photos on the internet of really green and ugly bodies of water. So it's an issue that's a very important issue and one that governments are concerned about. And one that is worth asking, well, what are some of the things that we could do about it? So in the last segment, we showed how economists can identify the optimal rate of an input such as a fertilizer, and optimal in the sense that it maximizes the farmer's profit. But in doing that, we've really ignored these other non-profit factors such as fertilizer. So we've ignored the possibility of an increasing risk of water pollution at higher fertilizer rates. So we can account for that if we can estimate what that relationship is between fertilizer rates and pollution. So let's assume that we can. We have the information that identifies what's the cost, the additional cost, related to water pollution that will result from using higher and higher levels of fertilizer in a particular farm and paddock. And in this diagram, I've assumed that we have that information. And just to illustrate it at least, I've assumed that it's linear. It may or may not be linear. If we know that it's not linear, that's fine. We can include a non-linear function. But just for this example, I've graphed it as a linear function. Once we have that information, what we can do is add it on to the cost function for the farmer. So that's what I've done in this graph. The dotted line-- the dashed line in this graph is the profit function for the-- I'm sorry, not the profit function, the cost function for the farmer due to the cost of purchasing and applying the fertilizer. It doesn't factor in the pollution cost. But the next line above that, the solid line, is the addition of the farmer's cost plus the pollution cost. And then we can go through the same sort of process that we went through in the previous segment of trying to identify the optimal level of application of fertilizer. And you can see that moving the cost curve up, effectively rotating it around in that way, indicates that the optimal level of fertilizer input should be slightly reduced or somewhat reduced. Now, the extent to which it's reduced will depend on the shape of both the production function, and that's the revenue curve, and the level of cost that the fertilizer is causing, and that's a case-by-case thing. But in this example, you can see that we've reduced the optimal level of fertilizer by a bit. We can also do that as we did in the previous segment. We can calculate the profit function as the difference between the revenue function and the cost function. We've got two different cost functions in this case, so that we've got two different profit functions. And again, you can see that the initial profit function that only factors in the profit to farmers, the dashed one, has a particular optimal level of fertilizer use. Once we factor in the cost of pollution, that curve moves down. But it moves down by more the further to the right you go. And so the optimal level of fertilizer falls, so the dashed line moves a bit to the left. Now, at the moment, I've assumed that we know what the pollution cost function looks like, but that can be pretty tricky. We may or may not know what that cost function looks like. And as I said, I assumed that that cost function is a straight line, and it may or may not be straight. It might be quite a non-linear shape in some cases. And depending on what that shape is, then that will influence the optimal fertilizer rate accounting for pollution. So economics-- this, I guess, is typical for economics, and particularly agricultural economics. You usually need to have good information about the biology and the physical aspects of the problem, not just the financial, more obviously, economic parts of the problem in order to answer the economic questions. It's a mixture. It's an integration of the biology and the economics in order to answer these management questions. So some of the implications of this are that in areas where water bodies are at risk, farmers who are responding optimally from a societal perspective would use a lower rate of fertilizer if they factored in the pollution costs. But however, they may not do this without support or some requirement for them to do so by government. And so in week 6, we'll look at government policy, including government policy about these sorts of things. I also mentioned briefly that pollution is what we've already referred to in previous segments as an external cost. So this is a good example of where it may be appropriate for a government to step in to try and reduce the level of an external cost. Just something we talked about in week 2. Of course, this type of pollution from nutrients, from fertilizers, is a long way from being the only type of pollution that's relevant. We also previously talked about the problem of sediment getting into waterways, the probability of problems from pesticides of various types. So the same sorts of production function thinking could be used to look at optimal changes to their management as well. So in summary, agricultural pollution imposes costs on society that aren't always reflected in farmer's decisions about their input levels. And if they did factor their pollution considerations in, they would use lower input rates in those situations where the inputs are causing pollution. [MUSIC PLAYING]
