1. FOR 451 ( FOREST RESOURCE ECONOMICS & QUANTITATIVE ANALYSIS) FORESTRY AND THE FREE MARKET Chapter 3 (Klemperer, 1996)

2. Forestry 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?

3. Forestry 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!

4. 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)

5. Required conditions for free market to maximize 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

6. Results when welfare is maximized 1. 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.

7. Market Failures & Government Actions 1.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 Act 4.Immobility of labor and capital - retraining programs, unemployment insurance, relocation assistance 5.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

8. 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 QsQs QpQp Social Marginal Cost Private Marginal Cost Pollution cost/ton of paper Social OptimumPrivate Optimum

9. Market Failures & Government Actions 6. 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

10. Acres forested near the city $/acre Fig. 3-4. Private and social optimum with unpriced positive side effects. 0 Private MR/acre QsQs QpQp Social MR/acre Private MC/acre Open space benefits, $/ac Private OptimumSocial Optimum

11. Market Failures & Government Actions 7.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

12. Optimal levels of environmental damage Non-Market, Environmental Econ: 2 Approaches or Damage Liability Rules: 1. Victim liability 2. Damager liability Damagers -- those causing damage Victims -- those harmed by damage Optimal level of environmental damage?

13. Optimal levels of environmental damage 1. 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)

14. Optimal Solutions with Monetary Damages (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

15. Optimal Solutions with Monetary Damages Use of bargaining framework to reach “optimal” environmental damage levels Figure 3-5a. Environmental damage costs and firm’s profit

16. Optimal Solutions with Monetary Damages A. Victim Liability –Bargaining framework -- see Figure 3-5b

17. Optimal Solutions with Monetary Damages B. Damager Liability –Bargaining framework -- see Figure 3-6

18. Optimal Solutions with Monetary Damages Optimal Solutions with Nonmonetary Damages – see Figure 3-7

19. Optimal Solutions with Monetary Damages Use 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!

20. Optimal Solutions … Damage Fines Transactions Costs Income Effects Placing Liability for Damage Reduction on –On Victims –On Damagers Changing Attitudes Avoiding Polarization

21. Applications in Forestry – p.92 Forestry Applications Table 3-1. Examples of forestry-caused environmental damage Figure 3-9. Optimum damage from logging.