FOR 451 ( FOREST RESOURCE FOR 451 ( FOREST RESOURCE ECONOMICS & QUANTITATIVE ANALYSIS)ECONOMICS & QUANTITATIVE ANALYSIS)

FORESTRY AND THE FREE MARKETChapter 3 (Klemperer, 1996)

Forestry and the Free MarketForestry and the Free Market• US forestry economy: Mixed ownership

– private forests often under public regulations

– public forest use dictated by private citizens

• Big Q: How much government intervention in private forestry is needed in market economy?

• If government intervenes (to improve social welfare): what kind of intervention, how much, when and where?

Forestry and the Free MarketForestry and the Free Market• Social objective (in using resources): to achieve a welfare maximum.

• Welfare maximum - elusive resource allocation, such that no reallocation could yield net gain

• If no change can bring net gains – at welfare maximum!

Forestry and the Free Market (continued)Forestry and the Free Market (continued)Other theories on maximization of welfare:

• Pareto Optimum -- no resource allocation could make anyone better off without making someone else worse off (1848-1923)

– More restrictive, narrow view

• Compensation principle -- allow resource reallocation, only when gains > losses, i.e., gainers could overcompensate losers (Kaldor, 1939)

Required conditions for free market to Required conditions for free market to maximize welfaremaximize welfare

1. Property rights to resources enforced -- clear definition of land and resource ownership

2. Firms & consumers are maximizers – they are rational

3. Perfect competition -- firms are price takers

4. Free entry of firms -- no barriers to entry to industry

5. Perfect information

6. Mobility of labor and capital

7. No unpriced negative side effects -- producers should pay for all costs

8. Priced inputs and outputs - all resources/outputs have a price

9. Satisfactory income distribution -- current/future income distrib. is ok

Results when welfare is maximizedResults when welfare is maximized1. Consumers' needs are met

2. Consumers maximize their satisfaction (apply equimarginal principle)

3. Efficient capital allocation -- best alternative rate of return to capital

4. Efficient allocation of labor & other resources -- move to highest returns

5. Producers have efficient levels of output -- optimal output level (max NR at MC=MR=P)

6. Efficient allocation of land -- most desirable use of land

7. No redistribution of income could yield any net benefit -- if redistributed, losses > benefits.

Market Failures & Government ActionsMarket Failures & Government Actions1. Property rights not enforced

- fish & game laws, licenses, fees, other forms of “rationing”2. Imperfect competition (monopoly/monopsony, oligopoly/oligopsony)

- Sherman Act of 1890, Clayton Act of 1914, 3. Imperfect information

- Truth in Advertising Act4. Immobility of labor and capital

- retraining programs, unemployment insurance, relocation assistance5. Unpriced negative side effects (“negative” externalities, or “external

diseconomies”)- ex: with pollution Social Optimum < Private Optimum- emission standards, tax incentives, direct payments for control measures, public funded programs

Tons of paper produced per year

$/ton

Fig. 3-3. Divergence between the private and social optimum with water pollution.

0

Marginal Revenue = price/ton

Qs Qp

Social Marginal CostPrivate Marginal Cost

Pollution cost/ton of paper

Social Optimum Private Optimum

Market Failures & Government ActionsMarket Failures & Government Actions6. Outputs not easily priced

- Public goods vs Private goods vs Mixed goods- “Positive” externalities (unmarketed positive by-products)

Social MR > Private MR Social Optimum > Private Optimum

- Option demand, Existence demand, Bequest value

- Actions: tax incentives/subsidies for providing unpriced goods (public goods), education programs about conservation practices, taxes/fines to discourage certain types of environmental damage, regulation of private forests, government ownership

Acres forested near the city

$/acre

Fig. 3-4. Private and social optimum with unpriced positive side effects.

0

Private MR/acre

QsQp

Social MR/acre

Private MC/acre

Open space benefits, $/ac

Private Optimum Social Optimum

Market Failures & Government ActionsMarket Failures & Government Actions7. Economic instability

- programs for price stabilization and support (subsidies)

- monetary & fiscal policies (stimulate investment, stabilize interest rates, dampen/stimulate demand)

8. Unsatisfactory income distribution

- progressive income taxation, programs like food stamps, welfare, free public services, assistance to low income students, low-income housing subsidies, social security

9. Other market failures?

- list provided not all-inclusive

- market failure is major justification for government intervention

- need to document market failure before government action

Optimal levels of environmental damageOptimal levels of environmental damageNon-Market, Environmental Econ:

2 Approaches or Damage Liability Rules:1. Victim liability2. Damager liability

Damagers -- those causing damageVictims -- those harmed by damage

Optimal level of environmental damage?

Optimal levels of environmental damageOptimal levels of environmental damage1. Victim liability -- with damage allowed, place liability on victims for

damage reduction; determine their WTP cost of damage reductions- Stresses private property rights (individual's right to do what they wish with their property)

2. Damager liability -- no uncompensated damage allowed, place liability on damager to compensate victims. - Compensation will be minimum $ payment that victims require to willingly endure damage. With compensated damage, victims would just be as satisfied as they were before damage occurred.

• - Stresses amenity rights or public's right to enjoy amenities (clean air/water, peace & quiet)

Optimal Solutions with Monetary Damages Optimal Solutions with Monetary Damages (Coase Theorem(Coase Theorem))

• Use of bargaining framework to reach “optimal” environmental damage levels

• Payments need not actually be made; need to only show that if payments were made, gains > costs

• Assumption: the only damage is reduced income to victims

Optimal Solutions with Monetary DamagesOptimal Solutions with Monetary Damages

• Use of bargaining framework to reach “optimal” environmental damage levels

• Figure 3-5a. Environmental damage costs and firm’s profit

Optimal Solutions with Monetary Damages Optimal Solutions with Monetary Damages

A. Victim Liability –Bargaining framework -- see Figure 3-5b

Optimal Solutions with Monetary DamagesOptimal Solutions with Monetary Damages

B. Damager Liability –Bargaining framework -- see Figure 3-6

Optimal Solutions with Monetary DamagesOptimal Solutions with Monetary Damages

Optimal Solutions with Nonmonetary Damages – see Figure 3-7

Optimal Solutions with Monetary DamagesOptimal Solutions with Monetary DamagesUse of the Declining Marginal Utility of Money

- Most rich folks added amount of $ today brings less satisfaction than same amount did when their income was much lower (empirical studies)

WTS > WTP :

- People’s required compensation (WTS) when losing a nonmarket amenity exceeds their WTP to attain it or save it from damage (studies)

- Other factors influence this situation, e.g., people hate to give up what they already have!

Optimal Solutions …Optimal Solutions …

• Damage Fines• Transactions Costs• Income Effects• Placing Liability for Damage Reduction on

– On Victims– On Damagers

• Changing Attitudes• Avoiding Polarization

Applications in Forestry – p.92Applications in Forestry – p.92

Forestry Applications

Table 3-1. Examples of forestry-caused environmental damage Figure 3-9. Optimum damage from logging.