The European Union’s Emission Trading Scheme (EUETS) and the current renewable resource program provide strong incentives to use agricultural crops either for combustion in power plants to produce electricity and heat or as a feedstock for transportation fuels. In this paper we examine the social desirability of ethanol production from agricultural crops. To endogenize the competition on land use, we employ a Ricardian model of heterogeneous land quality, where land is allocated to alternative crops on the basis of their relative profitability. The model comprises three land use types: bioenergy crop, conventional feed crop and green setaside. Industry demands crops for both ethanol and feed production. Effects on the GHG balance are explicitly taken into account in the analysis. Theoretical model characterises both the private and social optima and examines endogenous price effects. Theoretical framework is applied to barley production in Finland. We found that the socially optimal demand for barley is 13.3 % higher than demand obtained in the private optimum. This implies shifts in land allocation, fertilizer intensity and prices. Considering the climate impacts of crop cultivation, the land area devoted to green setaside greatly increases in the social optimum as compared with the private optimum.