Managerial heterogeneity and the compositional effect

Standard microeconomic theory has long recognized firm-level substitution and output effects in explaining aggregate responses to taxation of an input such as nitrogen fertilizer. However, in the presence of managerial heterogeneity, a nitrogen tax will also affect the composition of the industry, with profligate users of nitrogen shrinking in relative importance, and low-nitrogen users expanding. In this paper, we assert that a substantial share of the reduction in nitrogen normally attributed to firm-level substitution may in fact owe its origin to this type of industry-wide compositional effect. We also demonstrate that, while such a tax will have only a minor effect on industry average net returns, its impact on individual corn producers will be quite significant in some cases, with nitrogen-intensive producers losing while those farmers with low rates of commercial nitrogen usage stand to gain from the tax.