Impact Of Illegal Harvesting And Market Structure On The Sustainable Mahogany Trade

Illegal Harvesting and Government Interventions

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 products.
ii. Producers fear punishment and the consumption of mahogany products becomes desirable as consumers derive satisfaction from possessing illegal goods.
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.

(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.

For this task we consider some of the incentives faced by producers and their production decisions.
(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 mahogany.
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.

(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 collude.
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 population
3. Is collusion between the mahogany kings a sustainable long-run strategy Explain your answer.

1. Imposition of tax takes place by the government when it intends to curb demand or supply by procuring more money from either consumer or producer or both. In this context govt. wants to decrease the mahogany harvesting y taxing the producers or suppliers of such goods. Incidence of tax on producer shifts the supply curve upward or to left (to S₁) increasing equilibrium price (to P₁) and decreasing equilibrium quantity (to Q₁) in the mahogany harvesting market compared to the without tax scenario.Tax reduces the mutual exchange between buyers and suppliers that further leads to forgone producer as well as consumer surplus dropping the social welfare down and generating deadweight loss by the area of triangle E₁AE₀.
2. Limiting the harvesting of mahogany by imposing quota on the amount harvested (suppose at Q₁) through government intervention, the supply curve becomes vertical at Q₁ as the producer can’t supply more than the amount whatever be the price. Compared to equilibrium E₀ scenario, now the equilibrium price level reached at P₁which is pretty higher than before quota. The deadweight loss is being shown by the area of triangle ABCc)
3. i) Due to fear of punishment the producer will reduce its supply shifting the supply curve toward left to S Since the mahogany products are undesirable to consumers they cut back the demand too. The fall is demand not due to changes in price but due to changes in the taste and preference by them. As a result demand falls.Now what happens to equilibrium price and quantity depends on the amount o which demand falls. If demand falls by the same amount of fall in supply the price remains same though equilibrium quantity falls. If demand falls less than the supply falls then price drives up to P₁ and quantity is also at low than Q₀. If demand falls more than the fall in supply then the equilibrium price and quantity fall to P₃and Q_3.
4. ii) Due to disincentive to produce caused by punishment fear, the producers drops harvest which shifts supply curve to S₁. Taste and preference for mahogany harvest has increased by the consumers as a result demand shifts outward. What happens to equilibrium price and quantity is determined by the quantum of shift in the demand curve. Post shift equilibrium price will be higher in any cases but quantity supplied can fall, rise or stay constant at Q_{0 .}If demand rise more than fall in the supply then quantity rises and falls when the rise in demand is less than the fall in supply which is presented.

iii) Due to enforced law and monitoring against illegal harvesting, the producers drops harvest which shifts supply curve to S₁. No change in the desirability leads to no shift in demand and it remains constant at previous level. As a result equilibrium quantity falls to Q₁ and price rises to P_1.

1. Imposition of tax leads to higher price of the harvest in the market that affects both the supplier and consumer depending on the elasticity of their supply and demand. Coming to demand, if the mahogany harvest faces an inelastic demand in the market the even though tax is imposed, the higher price can’t successfully curb the equilibrium quantity in the market because for 1 unit increase in the price the demand will for less than 1 unit.According to the economist if consumers somehow can be manipulated to demand less then both the equilibrium quantity and price of mahogany harvest in the market will drop down that would further meet the government motive quite easily. 
2. i) The profit maximizing production decision regarding the mahogany harvest depends on what kind of market it is operating in. Almost for all kind of market structure, producer chooses to produce till the level of output where the profit it derives becomes maximum.For competitive market the production takes place P=MC=MR. In case of monopoly and monopolistic market the producer produce where marginal revenue gets equal to marginal cost and price is always higher than MR
3. ii) Pre 1999, the market for mahogany was legal but post that year, the harvesting and marketing of that became illegal. Still the market operation buying and selling them were active. These methods were able to avoid imposed tax, lower production cost and drive up the selling price than market price all of which lead to profitable supply. Considering the supplier to be a monopolist the short run production decision would be where MC=MR. Due to operating outside of the market and govt. regulation, the ATC as well as MC of the firm reduces that incentivizes the producer to supply more as a result illegal market supply rises to Q_B with fall in the highest level of price being charged.

iii) If illegal market now falls under government monitoring subject to strictly enforced laws then the producer won’t be able to supply at previous cost. Either the cost level would go higher creating disincentive to supply or the production would be restricted by the govt. itself. In such case the operating cost difference in the legal and illegal market would vanish and both the market would face same kind of restrictions and conditions imposed with regards to supply.

 b)-i) Since  a small elite group controls the market of mahogany locally it appears that the market structure is oligopolistic in nature where few seller are existent in the market. On the other hand export market is largely taken care of by two powerful players that indicate presence of duopoly market structure.

ii)-1) Since these two are only producers in the market, instead of supplying separately they enter into a collusion that help them set price and quantity set at level higher than the market equilibrium level. This increases the industry profit and pushes to maximized level. Without collusion firms had to share different level or profits with higher share of profit snatched by the leader compared to the follower in the duopolistic market.But collusion helps them share the profit equally and higher profit stems from higher market price than equilibrium while quantity supplied might be lower than equilibrium amount.

2) Duopolists collude in order to lower the market supply and increase the price level unnecessarily high so that they can derive chunk of the profit. This implies lower deforestation which is beneficial for the health of mahogany population.

3) Yes the collusion strategy if maintained for long time can lead to much lowered deforestation of mahogany trees. Since the colluders charge much higher price for low level of quantity supplied, the pressure on supply falls and overtime higher prices of harvest would create disincentives for the consumers. As a result in the long run the harvest would fall and that would be sustainable to the Brazilian ecology maintaining the balance.

b)

Table 1: Comparison of average homicide rates, municipalities with and without mahogany, different periods

1. From the above graphs and calculations, it can be said that the homicide rate is much higher in the mahogany growing areas. Over time, the rate has increased. It also reflects the existence of illegal trading and the impact of government intervention on it. From the above table, the pattern of the homicide rate can be explained. Prior to 1999, there was no government intervention in the mahogany production and trading. Hence, the homicide rate was quite low in both types of the region. During 1999 to 2001, when 85% of the licenses were revoked, the homicide rate increased little in the mahogany growing areas, while in areas without mahogany the rate was lower.Since 2001, when the harvesting was banned, the homicide rate in the mahogany growing areas increased significantly, which indicates the presence of illegal trading. These traders faced a huge loss and had no hope of recovering. Hence, the homicide rate increased. The difference between the homicide rates in these two types of region has increased considerably. Finally, post 2008, when the law was enforced, the homicide rate in the mahogany growing areas increased further. This indicates that the government intervention has helped in reducing the illegal trading of mahogany in the municipalities of Brazil.

Lessons and Reflections

1. a) Brazilian mahogany forest is world famous natural resources that require to be preserved than destruction. But falling prey of the human needs, greed and profit motive the forest is harvested without any limit.The first initiative that came from the govt. was to impose tax on producers to create disincentive for them to supply. But what has been learned that due to inelastic demand the quantity demanded did not fall as much the price of mahogany timber rose which attracted the producers to operate in the shadow market or illegal market to earn profit by meeting demands of consumers. Harvesting was still legal by then. The next step govt. took was to revoke 85% of license that further increased the intensity of illegal market operation and selling mahogany woods in disguise of  other normal timbers. Thus government regulation and control failed to meet the purpose behind such intervention that was evident in the even increased activity.

b)-i) If random harvesting is not regulated then the incentivized producer will follow the self interest and keeps on producing or supplying to quench own benefit and profit motives. When self interest can’s take care of the social welfare as whole by leading the allocation toward inefficiency, market failure appears in the context.Production than the social desirable level would create inefficient and adverse social impacts. The most dangerous impact being the loss of ecological balance, species surviving in such forests and so on.

ii)

1. One of the market based solution to reduce mahogany harvest locally has been the shifting growing of mahogany in other countries. If Brazil produces other goods in which it has comparative advantage and exchanges for the mahogany harvests from other country then it can avoid the present ecological issues.Now if Brazil engages in the production of mahogany then for one unit production of mahogany harvests, it has to let go some unit of the production of the goods which it was producing comparatively advantageously. Thus growing mahogany now would inflict higher opportunity cost.
2. The contextual study already presented government regulation as one of the solution to the issue and also the consequences have been studied. Another most important solution can be creating social awareness that can reduce mot only the supply but also the demands coming from range of consumers. Social campaigns and awareness programs can take care of the issue on a large scale. As this would act as greater factor to make shift in both supply and demand.

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