The new Rural Development Regulation of the EU reflects the shift of attention within rural areas from agricultural production towards rural development and embraces both, farmers and non-farm residents. While agricultural production is required to comply with environmental standards, rural areas also have to fulfil the growing demand for landscape, outdoor recreation and wildlife conservation. This paper develops a model of a rural area where farmers and non-farm residents live together. A central government uses a combination of two-policy instruments--direct compensation payments and public services -- aimed at encouraging farmers to adopt environmentally beneficial practices and at the same time to increase the provision of country-side amenities and the sustained vitality of the rural area. The optimal mix of the policy instruments is evaluated under various governmental objectives. The analysis suggests that a combination of direct payments to farmers with the supply of local public services is a promising tool for rural policy development initiatives in the EU.