Task A: Welfare Effects of Government Intervention
For this task you need to consider the market for mahogany from a theoretical
perspective, i.e. you do not need to analyse data. To simplify the analysis we will
assume that there are no externalities involved in the production or consumption of
mahogany. (Externalities are discussed in week 9 of the course.)
(a) In an attempt to reduce the harvesting of mahogany, the Brazilian government
introduced a tax on producers for each ton of mahogany harvested. Use a demand
and supply diagram to illustrate the market for big leaf mahogany before and after
the tax. Explain the impact of the tax on equilibrium price, quantity traded, and
welfare. (For this question assume a standard downward sloping demand curve
and upward sloping supply curve.)
(b) In 1998, the Brazilian government introduced a harvesting quota that limited how
much mahogany could be harvested. Use a demand and supply diagram to
illustrate and explain the impact of the quota on equilibrium price, quantity traded,
and welfare. (For this question ignore the existence of the tax.)
(c) In 2001, the harvesting of mahogany was made illegal. For each of the following
three scenarios, use a separate demand and supply diagram to illustrate and
briefly discuss what happens to the equilibrium price and quantity traded. (Hint:
consider whether the change affects any of the determinants of demand or of
supply, and in which direction.)
i. Producers fear punishment and the consumption of mahogany products
becomes undesirable because of the stigma associated with possessing such
ii. Producers fear punishment and the consumption of mahogany products
becomes desirable as consumers derive satisfaction from possessing illegal
iii. In 2008, the Brazilian government significantly improved its monitoring of
illegal harvesting, enforced the law, and increased penalties for illegal
harvesting. Producers fear punishment and there is no change in the
desirability of mahogany.
(3 + 3 + 3 = 9 Marks Total for (c))
(d) An economist advises the Brazilian government that the tax discussed in (a) above
will be ineffective in reducing the harvesting of mahogany if the demand for
mahogany is very inelastic. Her advice is that a more effective way to reduce
mahogany harvesting is to reduce demand for mahogany. Use a diagram to
explain the logic behind this economist’s advice.
(27 Marks Total for Task A)
Task B: Production Decisions
For this task we consider some of the incentives faced by producers and their
(a) According to an OECD report (2007, p. 19-20): “Illegal wood is not burdened by
taxes, stumpage fees and expenses for compliance with forest and environmental
regulations. It is therefore cheaper to produce than legal wood. … illegal logging
is substantially more profitable than the legal kind and that there is therefore a
clear financial incentive to engage in illegal activities.”
For questions (i) to (iii) below we will compare legal to illegal harvesting. For these
questions assume that demand remains the same for both legal and illegal
operators and assume that there are numerous competing firms with no barriers
to entry or exit.
i. Harvesting mahogany was legal until 2001. With the aid of a diagram illustrate
the profit maximising production decision of firms that were legally harvesting
ii. In 1999 the Brazilian government revoked 85% of harvesting licenses.
However, there was little attempt to enforce the law; firms were able to sell
mahogany in the guise of other types of timber and illegal trade was enabled
by corrupt officials. Moreover, firms that operated illegally no longer needed
to meet regulatory requirements and could avoid paying taxes. On the same
diagram as (i) above, illustrate and explain the incentives and short-run profit
maximising production decisions of firms that are illegally harvesting
mahogany. (For this question assume that the total number of firms remains
unchanged; firms that lose their license to operate legally are replaced by firms
who operate illegally.)
iii. Now consider what happens if the Brazilian government starts to enforce the
law to prevent illegal harvesting. What happens to the operating cost
differences between legal and illegal harvesting firms? Explain your reasoning.
(No diagrams are required for this question.)
(3 + 5 + 2 = 10 Marks)
(b) A Greenpeace report (2001, p. 8) argued that the Brazilian mahogany trade: “is
dominated by a small élite group of sawmills and exporters controlled largely by
two powerful players: Moisés Carvalho Pereira and Osmar Alves Ferreira.
Between them, these two mahogany kings …. control over 80% of the total
mahogany timber export trade from Pará.”
i. If Greenpeace’s depiction is correct, what does it imply about the structure of
the mahogany market? Explain your reasoning.
ii. Instead of competing against each other, Pereira and Ferreira decide to
1. With the aid of a diagram illustrate and explain the consequences on the
price of mahogany and profits for the mahogany kings in the short-run.
2. What is the impact of collusion on the health of the mahogany tree
3. Is collusion between the mahogany kings a sustainable long-run strategy?
Explain your answer.
(2 + 5 + 1 + 3 = 11 Marks Total for (b))
(21 Marks Total for Task B)