Derived Demand, Timber Values, & RentChapters 3 and 10

Input Markets

No direct demand for logs for the most part…

http://www.hellocotton.com/decorating-a-wall-with-slices-of-wood-logs-1251305

http://www.homedit.com/interesting-diy-outdoor-table-of-wood-logs/

Derived Demand

The demand for inputs by firms is similar to demand for goods and services by consumers

Difference is that demand for forest products is usually derived from demand for other goods (housing, newspapers, magazines, furniture)

As such demand for lumber is based on the supply of lumber, along with other inputs, used in making the product

Illustrating Derived Demand

Demand for housing

Demand for softwood lumber

Price homes

Price lumber

Quantity homes

Quantity lumber

Supply homes

Supply other inputs

Supply lumber

Shaded area here indicates a willingness to pay after deducting the cost of all the other inputs

This is then the demand curve for that input-in this case, lumber

Example of Final and Input Markets

From Yanshu Li and Daowei Zhang. 2006. Incidence of the 1996 U.S.–Canada Softwood Lumber Agreement among Landowners, Loggers, and Lumber Manufacturers in the U.S. South. Forest Science.

Timber Supply

Short-run

Long-run (conventional and very long-term)

SVLR

D

sSL

R

The Extensive Margin

Stands vary in terms of their Timber Value

Timber Supply is drawn from the Timber Inventory

The Timber Inventory is sensitive to values and costs

Total inventory

Economically recoverable inventory

Q

Net value ($/m3)

Timber Supply

P

MC

C

0

P=MR

P*

Q

Producer Surplus

Perfect Competition

Profits, economic rent, and producer surplus

What is the difference between zero or normal profits, economic profits, and economic rent? In standard assumption of perfectly competitive markets,

all factors of production are freely available, and opportunity cost is market price of using them (wages, rental for capital)

Therefore there is no “profit” under standard assumptions of perfect competition-there are zero or “normal” profits

Under perfect competition (economic) profits are a sign of disequilibrium

Economic Rent

Economic rent occurs when we modify our assumption of perfect competition

In resource economics there are two main ways in which it can appear

market imperfections (market power or distortions)

Or from inherent differences in the productivity/quality of a resource

Economic Rent (2)

Economic rent is the difference between the price paid for the factor and its opportunity cost (its best alternative use)

The rule of thumb is to assign this “excess profit” to the factor that is scarce

Characteristic of resource economics Land for housing in

Vancouver Forests in BC Ore deposits

Economic rent is the return to a scarce input factor over and above the opportunity cost of bringing it into production.

Profits or Rent?

Assume you have some more productive forest land so you can grow 10% more timber than anyone else

Does this mean that your costs are 10% lower? No, it is the quality of the land You could lease the land and enjoy the rents associated with

the higher payments because of the productivity

Therefore, these excess profits are assigned to the land and called scarcity rent or economic rent

S

R

$

Q/t

Qs

Qd

p

q

S Consumer SurplusR Economic Rent

Economic Rent

P

MC

C

0

P=MR

P*

Q

Producer Surplus

Perfect Competition (?)

$/m3

Volume Recovered m3

MC

C

0

MRR

V

Economic Rent

$/m3

Volume Recovered m3

MC

C

0

MRP

V

Economic Rent

Why is it important?

Two main reasons:First, rent measures a payment above and beyond that required to keep the factor in production we can collect that rent without changing the production decision (maintains efficiency)Second, from the perspective of the Crown, this represents the return to the public (a distributional goal)

$/m3

Volume Recovered m3

MC

C

0

MRP

V

Economic Rent collected by the government

Different Stumpage Methods Have Different Outcomes Two types:

Lump Sum: One price to pay to access all the timber (could be appraisal or competitive bid)-in theory could bid up to the full amount and harvest at the optimal level, VFixed Charge: A payment on a per cubic metre basis (e.g. $X per m3). This can be determined administratively (through formulas) or you could bid it as well.

V’

Stumpage

Economic Rent retained by the logger

Deadweight loss

Utilization Standards

Why Do we Have Utilization Standards?

P

Q

p*

q*

D

S

q1 q2

Consumer Surplus

Producer Surplus

Deadweight Loss as a measure of inefficiency

The purpose of utilization standards

http://www.for.gov.bc.ca/BCTS/bulletins/Cruise_based_TSL_QA_Oct_2_09.pdf

• Stumpage is a term used to describe the price paid for standing timber.

Our focus here is on using it to denote the price paid to the Crown.

Stumpage

81/82

83/84

d85/

8687/

8889/

9091/

92f

93/94

95/96

h97/

98h

99/00

01/02

04/05

07/08

09/10

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

$1,400,000

$1,600,000

$1,800,000

$2,000,000

Stumpage/Government Revenues in BC, 1981-2010, 000’s of Canadian dollars

• Fixed Schedules

• Appraisals

• Competitive Auctions Speaker next Tuesday will speak to this

Alternative Stumpage Systems