Shadow price and Shadow wage rate

ConceptDistortions in prices

Two approaches of shadow pricingExamples of shadow pricing

Shadow wage rate

• In a purely competitive market, market price can be used in economic analysis because in such markets, the market price reflects the real scarcity of the goods/services to the society.

• The price at which a producer purchases a producer’s good/service/resource – production factors such as labour, capital and non-factor inputs (seedlings, fertilisers) – is ultimately based on the price of the consumers’ good he produces.

• In a competitive market the price of a producers’ good reflects the marginal productivity of the production factor used and their opportunity cost (the opportunity cost of a production factor is the net value of a production in the situation without the project that is foregone when the factor is used in the project).

• Hence, in a competitive market the market prices of the production factor can be used.

• However, the market is not always perfectly competitive due to the following reasons:

• - Distortions in the market due to government policy (import quota, tariffs, subsidies, rationing, price control)

• - The existence of involuntary unemployment because of high minimum wage rate

• - Monopolies and monopsonies• External effects, which exist wherever an

economic activity in the form of production or consumption affects the production or utility levels of other products or consumers, and the effect is unpriced or uncompensated (Dasgupta and Pearce, 1978).

• Under the above mentioned situations, the market price do not reflect the real scarcity to the society.

• In Economic analysis, the distortion in the price is removed by calculating new prices that do reflect the real scarcity to society.

• These prices are called accounting, efficiency or shadow prices and in developing countries the difference between the efficiency price and shadow price can be considerable because the markets are less competitive than markets in industrialized countries.

Two approaches in removing price distortions

• UNIDO approach (1972) developed by Dasgupta, Sen and Marglin tries to correct domestic prices if distortions exist

• OECD approach (Little and Mirrlees, 1974) takes international prices as a base for accounting prices – border price of traded goods reflect real opportunities open to the economy. This approach is used widely by international organisations.

• The ratio of efficiency price and the market price is called the Conversion factor and the Central Planning Office has often available the conversion factor of a large number of goods and services.

• The conversion factor also include the extent to which the currency is often overvalued and an accounting exchange rate has to be used.

• A large number of forest products can be in principle exchange on the market but they are actually not sold on a market. The goods are usually consumed by the producers’ or collectors’ household (e.g., NTFP). If there is a competitive market in the village where these products are traded then we can take this market price, but marketing costs have to be deducted.

• If no market prices are available, then the value of these products are to be derived from products otherwise people had used, so called substitute products. An example of pricing fuelwood from substitute product – kerosene is given as an example.

Estimating firewood value using kerosene as substitute

Project output FuelwoodSubstitute product Kerosene with CIF price $0.40/litreCaloric value Kerosene 3200 kcal/lit

air-dry wood 188000 kcal/m3

Imputed substitutionFor wood

$/m3 = $0.40 / 3200 kcal188,000

$/m3 = (188000 * $0.40 ) / 3200 = $ 23.50

Source: Gregersen and Contreras, 1979.

Derivation of shadow price for project fuelwood substituting crop residues

(Hypothetical example)• Basic information

- Crop residue removed per ha/yr 2 tons

- Corn crop value increase per ha/yr

if residues left on fields $20

- Heating value of 2 tons crop residue 376000 kcal

- Heating value of 1 m3 of project fuelwood 188,000 kcal

Calculation of fuelwood shadow price

- Heating value of 1 m3 of project fuelwood = heating value of 1 ton of crop residue

- Corn crop value increase due to 1 ton of

crop residue = $ 20/2 = $10

Value of 1 m3 of fuelwood = $ 10

Source: Gregersen and Contreras, 1979.

Shadow wage rateSocial wage rate is concerned with the monetary transfer

resulting from employment. The question is - who is advantaged, who is disadvantaged, and by how much?

If decision to accept forestry work was rational, then { forestry wage} - { extra disbenefit} > { former wage} Therefore, { forestry wage} - { former wage} > { extra disbenefit} (> 0)(Disbenefit: leisure time given up + dissatisfaction caused by

work)

Those affected may includea. The workerb. Those who take on some of the workers prior employmentc. The workers former employer (if any)d. The workers new employere. The government, even if not involved as an employer

• In estimating shadow wage rate with extra person employed in a project, it is necessary to consider three different types of costs, namely: foregone marginal product, changes in consumption and savings, and changes in leisure.

• According to marginal productivity theory, labour will be hired up to the at which the marginal value product equals the wage.

• Transfer of labour from rural to urban setting is associated with changes in saving and consumption. Increase in consumption may accrue to more than one labour.

• Changes in leisure will have impact on disbenefit factor of employment.