Modelling Environmental Risk Using the Upper Partial Moment: a Safety-First Approach

The objective of the paper is to model economic-environmental trade-offs using a safety-first approach. The novelty of the approach is in the use of the empirically estimated flexible production risk and environmental risk functions that create a clear link between the source of the pollution, the production risk due to input use and the environmental outcome. Simulated production data and an environmental indicator were used to estimate a production function and environmental response function for every production year. The response functions were incorporated into an upper partial moment model, which ensures compliance to the user-specified environmental goal by enforcing the environmental constraint. Production decisions are significantly impacted by the presence of an environmental constraint due to the substantial compliance costs. Any changes in the intensive and extensive margin made by risk-averse decision-makers impact the size of the compliance cost faced by producers. The presence of an environmental constraint impact production decisions significantly with substantial compliance costs. While, fertiliser application technique have very little effect on the size of compliance costs. The greatest difference in compliance cost is therefore due to changes in the use of fixed resources.