Preserved Farmland: An External Benefit

Preserved farmland yields both benefits and costs to society. In the absence of government intervention, the farmer who wants to sell his land incurs all the costs of preservation—namely, the forgone profit to be made from selling the farmland to a developer. But the benefits of preserved farmland accrue not to the farmer but to neighboring residents, who have no right to influence how the farmland is disposed of.

Figure 16-4 illustrates society’s problem. The marginal social cost of preserved farmland, shown by the MSC curve, is the additional cost imposed on society by an additional acre of such farmland. This represents the forgone profits that would have accrued to farmers if they had sold their land to developers. The line is upward sloping because when very few acres are preserved and there is plenty of land available for development, the profit that could be made from selling an acre to a developer is small. But as the number of preserved acres increases and few are left for development, the amount a developer is willing to pay for them, and therefore the forgone profit, increases as well.

Why a Market Economy Preserves Too Little Farmland Without government intervention, the quantity of preserved farmland will be zero, the level at which the marginal social cost of preservation is zero. This is an inefficiently low quantity of preserved farmland: the marginal social benefit is $20,000, but the marginal social cost is zero. An optimal Pigouvian subsidy of $10,000, the value of the marginal social benefit of preservation when it equals the marginal social cost, can move the market to the socially optimal level of preservation, QOPT.

The MSB curve represents the marginal social benefit of preserved farmland. It is the additional benefit that accrues to society—in this case, the farmer’s neighbors—when an additional acre of farmland is preserved. The curve is downward sloping because as more farmland is preserved, the benefit to society of preserving another acre falls.

As Figure 16-4 shows, the socially optimal point, O, occurs when the marginal social cost and the marginal social benefit are equalized—here, at a price of $10,000 per acre. At the socially optimal point, QOPT acres of farmland are preserved.

The market alone will not provide QOPT acres of preserved farmland. Instead, in the market outcome no acres will be preserved; the level of preserved farmland, QMKT, is equal to zero. That’s because farmers will set the marginal social cost of preservation—their forgone profits—at zero and sell all their acres to developers.

Because farmers bear the entire cost of preservation but gain none of the benefits, an inefficiently low quantity of acres will be preserved in the market outcome.

A Pigouvian subsidy is a payment designed to encourage activities that yield external benefits.

This is clearly inefficient because at zero acres preserved, the marginal social benefit of preserving an acre of farmland is $20,000. So how can the economy be induced to produce QOPT acres of preserved farmland, the socially optimal level? The answer is a Pigouvian subsidy: a payment designed to encourage activities that yield external benefits. The optimal Pigouvian subsidy, as shown in Figure 16-4, is equal to the marginal social benefit of preserved farmland at the socially optimal level, QOPT —that is, $10,000 per acre.

So New Jersey voters are indeed implementing the right policy to raise their social welfare—taxing themselves in order to provide subsidies for farmland preservation.