Factor-input demand subject to economic and environmental risk: nitrogen fertilizer in Kansas dryland corn production

Factor-input demand should be affected when a producer considers environmental risks in the decision-making process; this is a straight forward application of the LeChatelier Principle. The two-fold purpose of this study is to develop a model to estimate environmental costs arising from excess factor inputs and to examine how firm-level factor-input demand is affected by economic and environmental risk. Nitrogen fertilizer use in northeast Kansas dryland corn production is used as an example. Weather and corn growth simulation models were used to generate 50-year distributions of dryland corn yields and potential environmental damage (surplus nitrogen). A model for approximating external environmental costs of surplus factor inputs was developed. Private (environmental costs not included) and social (environmental costs included) net returns distributions were generated for 1991 Farm Bill program participation and non-participation. Stochastic dominance analysis with respect to a function was used to identify the risk-efficient fertilizer strategies from among the 24 private and 24 social net returns distributions. Constrained (private) and unconstrained (social) nitrogen fertilizer demand schedules were then approximated on a per-pound of fertilizer basis as measures of the incremental value of nitrogen fertilizer. As expected, the results suggest that: (1) in the absence of environmental risk, nitrogen demand is more elastic as a producer becomes more risk averse; and (2) when environmental risk is introduced into the decision-making process, nitrogen demand is more elastic than when environmental risk is excluded. The findings support the hypothesis that producers, when provided with information regarding the potential environmental effects of production strategies, may choose those that are more environmentally benign.