Forest degradation, manifested through decline in forest cover, and the resulting soil erosion losses, are a serious problem caused by a complex coupling of bio physical, socioeconomic and technological factors in the Himalayan watersheds of Asia. Greater understanding of the linkages among these factors requires a systems approach. Such an approach is proposed using a bio-economic model to explore the system behaviour of forest degradation and soil erosion in the forest areas. The model considers a watershed aggregate utility maximization objective function consisting of the following main components: net cash income from crops, animals and forest products, including the imputed value of the stock; leisure time for family labour; and basic requirements for food grains, cash, fuelwood and fodder. The model is applied to the Mardi watershed in Nepal, and the approach appears to be feasible for analysing the degradation of forests and soils over a long-term horizon.