Theoretical Analysis Of The Market For Mahogany And Government Intervention

Welfare Effects of Government Intervention

Various policies are adopted by government in order to stabilize economy and one such policy is tax imposition, as a result of imposition of tax, buyers or sellers mainly faces constraint in terms of price differentiation. Tax imposition also creates more revenue to government funding (Pollack, 2012). The increasing harvest of mahogany in Brazil draw the attention of government and as a result government decided  to reduce the harvesting by making the goods costlier through imposition tax payment for each unit of production.

Figure 1: Tax Regulation imposed in Mahogany Market

Tax imposition on seller leads to movement of supply curve upward direction and for this reason supply decreased in the market to avoid the tax payment. The reduction in supply with same demand demanded leads to higher market price after tax implementation and the equilibrium quantity supplied in the market falls from Q₀ to Q₁. Tax thus reduces the amount exchanged between buyers and suppliers and this in turn leads to loss of both the producer as well as consumer surplus. This result creates forgone social welfare and generates deadweight loss which is shown by the area E₁AE₀ in the above diagram.

Quota is a regulatory policy implemented by the government to impose restriction on the quantity supplied in the market. It sets limit on production and supply in the market (Pothen and Fink, 2015.). Government imposed quota on maximum harvest amount of mahogany in order to tackle problem associated with it. This step resulted in vertical supply curve vertical with quantity level to Q₁ beyond  this quantity level the supplier cannot supply .The vertical supply curve resulted in movement of  equilibrium price at P1 which is higher than the previous equilibrium  price E₀ . The area of  ABC in the below figure shows  deadweight loss that creates leakage of social welfare. 

Figure 2: Quota in Mahogany Harvesting Market

c)i) The rigorous action taken against sellers can create disincentive to suppliers and this is evident from the above diagram which shows supply curve moves towards left to S The decrease in demand of mahogany woods and related products to consumers fall in demand that in turn causes downward shift of the demand curve. The fall in demand thus shows change in taste and preference of the consumer. Equilibrium price and quantity as a result of imposition of tax and quota changed and for this demand and supply also changed

Production Decisions

Figure 3: Fall in DD & SS in Mahogany  Market

Fall of demand by the same amount of fall in supply keeps the price unchanged though equilibrium quantity falls. Demand fall that is less than the fall in supply drives price up to P1 and equilibrium quantity is lowered. Demand fall more than the fall in supply puts down the equilibrium price and quantity to P3 and Q3.

ii) The fear of punishment and strict action undertaken against harvesting of mahogany leads to fall in incentive to produce which is shown by the shift of supply curve to S₁(Benkovskis and Worz, 2014).The desirability of the mahogany harvest increases which in turn increases taste and preferences shifting the demand curve upward. The degree of shift in the demand curve determines the equilibrium price and quantity in market. Post shift equilibrium price will be higher for all the cases but quantity supplied can fall, rise or stay constant at Q If demand rises more than fall in supply then quantity rises and it falls when the increase in demand is less than the fall in supply.

Figure 4: Change of Taste & Preference

iii) The next step taken by governing authorities toward intention of reducing the mahogany harvest is to enforce law and application strict monitoring against illegal harvesting. These lead to fall in harvest made by the producer which shifts supply curve to S₁. But due to absence of change in the desirability no shift in demand takes place and further remains constant at previous level. This leads to fall in equilibrium quantity to Q₁ and price rises to P_1.

Figure 5: Impact of Monitoring in Mahogany Harvest Market

d) Tax imposition affects the buyer or seller and the degree of affect depends on the incidence of tax on them. The burden of tax is determined by the elasticity of demand and supply faced by each supplier. The inelastic demand for mahogany harvests proved to be unsuccessful to reduce the quantity demanded even though tax imposition leads to higher price of the good (Cleaver, 2013). Inelasticity of demand reflects fall of demand by less than one unit for unit rise in price level. The economist focused on less demand generated in the market as a policy to control the entire market activity of mahogany harvests.

Figure 6: Reducing Consumption of Mahogany Harvest

Lower demand along with the same level of supply will cause lower equilibrium price as well as quantity (shown by P₁ and Q₁). Lower price will cause the producer to drop the harvest and the purpose borne by the government in order to regulate the harvests would be achieved.

Impact on the Homicide Rate

a)i) Market structure determines the conditions of  profit maximizing production decision of the producers. Irrespective of the market structure the producers operate till the point where it manages to maintain higher profit from the production process.

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. If we consider mahogany market is monopoly or oligopoly with presence of few sellers then seller maximizes profit at the point of production where MC=MR with falling ATC.

Figure 7: Profit Maximized Production in Mahogany Market

ii) Before the year 1999, the market operation of mahogany timbers was legal and free of issues. Post this year government took control of the market regulation that focused on mahogany harvests. Inspite of various regulations, the demand and supply of the timber were intact creating room for illegal market or shadow market.This was profitable option for producers since they could avoid 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 at MC=MR. Since the operation takes place outside of the market and lack of govt. supervision, the average total cost falls leading to lower marginal cost of the firm. This provoked the producer to supply more leading to hike in illegal market supply to Q_B with fall in the maximum price being charged.

Figure 8: Profit Maximized Production in Shadow Market of Mahogany

iii) Stringent supervision and monitoring by government in terms of enforced laws leads to restricted supply made by the seller. Suppliers have to pay tax or follow quota or even stop production all of which are demotivating for him as a producer. Supplying at previous cost is not permissible now and as a result cost can go up discarding producer’s incentive to supply. The differentiation in operating cost in the legal and illegal market will drive down to zero if government regulates the black market activities.

b)i) The mahogany timber market is controlled by a small group of people and this implies there are few sellers inthe market. This reflects oligopolistic market structure operation. The export of the good is conducted mostly by two powerful players representing presence of duopoly market structure.

ii)1) There are two producers present in duopoly market and presence of price war is often common when they make supply decision and strategy separately. To avoid the loss of profit by biased distribution of goods, they enter into a collusion or cartel that help them set to price and quantity  at a level higher than the market equilibrium level(Dunne, 2013). As a result industry profits also increases and reaches maximum level. Without collusion firms had to share different level of profits with higher share of profit snatched by the price leader compared to the follower in the duopolistic market. Cartel helps them to share  profit equally by generating higher profit from market by driving up the market price while lowering quantity supplied.

Lessons and Reflection

2)  The collusion signed by the duopolist leads to high market price and low supply as a result price increases. Higher price creates disincentive in the demand made for them. Low supply indicates lower rate of deforestation that shows good health of the mahogany forests.

3) In the collusion strategy, resulting low level of supply is the decision made by the producers only. This is done to set the market price at much higher level than the equilibrium level (Feng,2012). The result can be fall in demand that matches with the low level of supply 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 of ecology with reduced deforestation.

a)

Graph 1: Homicide rate for all Para Municipalities for the year 1995 – 2013

b)

Figure 11;Average Homicide rate for all Para Municipalities for the year 1995 – 2013

(Source: Author)

Period (1)	Areas with mahogany (2)	Areas without mahogany (3)	Homicide rate difference between municipalities (4)
Pre-1999. Pre major government intervention	12.41835	6.154223	6.264131
1999 to 2001. 85% of licenses revoked	19.43157	5.009476	14.4221
2001-2008. Harvesting banned	34.16096	10.02253	24.13843
Post-2008. The law is enforced	44.84869	21.26008	23.58861

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

c)   The graphical representation based on the panel data of 128 municipalities  of Brazil over the period of 1995-2013, depicts the higher rate of homicide rate in areas prone to mahogany growth. The trend and pattern implies the overtime increase in the rate. The impact of government intervention and illegal trading exist ( Del Guercio,2013).Prior to 1999, there was absence government intervention in the mahogany production and trading hence no problem of the homicide rate existed  in both regions. During 1999 to 2001, govt. revoked 85% of license regulating the production which pushed the homicide little high in the mahogany growing areas. The rate was low at areas without mahogany. Since 2001, the harvesting was banned strictly and this had greater impact on homicide rate which increased significantly in the mahogany growing areas. This led to presence and increase in illegal transactions (Hyman,2014).

From the study it is evident that the difference between the homicide rates in these two types of region has increased considerably. Post 2008 law enforcements led to  high level of homicide rate in the mahogany growing areas. Though unfortunate for the suppliers and traders, the statistics conclude that the government intervention has been able to reduce but not totally abolished illegal trading of mahogany in the municipalities of Brazil.

a) Mahogany forest is one of the significant factor of Brazilian economy. This precious natural resource of the country should be well preserved and not destroyed (Gandolfo 2013). But with urbanization, pressure of population and increasing human need and demand in terms of consumption, yielding profit large scale harvest of mahogany continued. Government intervened to tackle the growing issue in form of tax imposition initially with the motive of curbing demand and supply. But this could not stand out well in front of the rising and inelastic demand that the market of mahogany timbers faces (Nicholson and Snyder 2014). The regulation in the market and consequent higher price led to operation of shadow market or illegal market  to earn profit by meeting demands of consumers. Mahogany harvest was not even illegal initially. The next step of the govt. was to revoke 85% of license. This intensified illegal market operation and selling and exporting of  the mahogany woods in disguise of  other normal timbers increased as per the export data. Thus government regulation and control failed to meet the purpose behind such intervention that intensified black market  trading even though the intervention seem doing well on the surface analysis.

b)i) Market failure is an obvious consequence of adverse self-interest impacting in  social welfare motives. Individuals are driven by self-interest. But when self-interest of one creates external impact on other social agents that leads to larger social marginal cost exceeding social marginal benefit ( Boutelle, 2014),This also indicates inefficient allocation of resources that results in low production of social welfare. Unregulated harvest would induce the producers keep on harvesting randomly to meet their self-interest of profit out of the supply in market (Knight, 2012. ). Production above the social desirable level would create inefficient and adverse social impacts. The most hazardous impact is ecological misbalance and threat of existence of the species surviving in such forests.

ii)Apart from government regulation on the local producers and traders, another market based solution can be, shifting the location of mahogany production and harvests in other countries in order to nullify the existent ecological issue growing around random deforestation (Negreros-Castillo and Mize, 2013). Brazil enjoys geographical advantage of possessing such rich natural resource. Now if Brazil stops this production and prefers importing the good from other regions then it has to provide some other good to those regions in exchange. The exchanged good would be in line of the production in which the country enjoys comparative advantage which helps it impose lower opportunity cost engaged in production (Free et al. 2014). After shifting the location of growing mahogany if Brazil is to produce mahogany timbers then that would raise the opportunity cost because it would have to produce something in which it does not have advantage and cutting back the production having comparative advantage (Copeland and Taylor 2013). This trade off falls thus adversely affects economic performance of the country. 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 impose higher opportunity cost.

The background of the analysis presents how government regulation was imposed as one of the solution to the issue revolving around random harvesting of mahogany.  The consequences that have been identified are interesting with leading rise in the illegal market and trading activities (Joossens and Raw, 2012). The export trend shows growing trend the more government shifts to stricter regulations leading to lesser concrete impact of the government motive. In such scenario, another most important solution can be generating and boosting social awareness that can effectively reduce both the supply and the demands operating in the market (Ruttan and Thirtle, 2014). Social campaigns and awareness programs have large impact on this issue since this would act as an important element to make shift in both supply and demand decision from the core

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