ACE 310 Exam 2

Todays plan of action
Natural Monopoly
Allocation of Surface Water
Riparian Doctrine
Prior Appropriations Doctrine
Allocation of Groundwater
INTRODUCTION
Feb 27 Water Doctrine F5 Water Q5 Water
Surface Water Resource Resource
Economics Economics
Mar 1 Groundwater
Mar 3D Discuss HW #5 Water
Resource Economics
Discussion Problem #5
Mar 4 HW #5 Water
Resource
Economics
Mar 6 Fisheries F6 Fisheries Q6 Fisheries
Economics Economics
Mar 8 Fisheries
Mar 10D Review HW #5 Water
Resource Economics
Discuss HW #6
Fisheries Economics
Mar 11 HW #6 Fisheries
Economics
Mar 13 Fisheries Economics F7 Forest Q7 Forest
Economics Economics
Mar 15 Forest Economics
Mar 17D NO CLASS NO CLASS NO CLASS
INTRODUCTION
Announcements
Posted
Study Guide for Quiz 6
Quiz 6 Due Monday, March 6 at 10:30 am
Posted Soon
Homework Assignment #5 Due Saturday
Exam return--not sure on date yet
INTRODUCTION
Learning Objectives this Section
Familiarity with surface water allocation and
use
Familiarity with the problems of open access
externalities
Be able to set up the objective function and
state equation for use of groundwater
Learn standard problem set up for maximizing
the NPV of a resource over time
Be able to characterize optimal behavior to use
groundwater
INTRODUCTION
QD How should we manage a natural monopoly?
Natural Monopoly
high fixed costs
low variable costs
declining average costs
Examples
Utilities (Electricity, gas, water, sewage)
Travel Infrastructure (air, auto, rail)
Cable (Computer, TV)
NATURAL
MONOOPOLY
Natural monopoly & average cost pricing
$
D
ATC
PMC MC
(0,0) QMC Q
NATURAL
MONOPOLY
Natural monopoly & average cost pricing
Often Regulated--What usage fee to charge?
MC !!
$
D
PATC
ATC
PMC MC
(0,0) QATC QMC Q
NATURAL
MONOPOLY
Allocation of Surface Water in the U.S.
QE-What are the differences between the Riparian
and Prior Appropriations Doctrines
Riparian Doctrine:
Rights to use water belongs to the people, who own land
next to the water as long as no one is harmed
Prior Appropriations Doctrine:

First in time implies first in right
Water rights are separate from land ownership
Establish a water right, by diverting for beneficial use
SURFACE WATER
Riparian Doctrine:
Think Eastern U.S. & Lakes
Lake
SURFACE WATERr
QF-Where did the Riparian Doctrine develop?
Abundant Public Supply (Eastern U.S)
Price
(0,0) Quantity
RIPARIAN
DOCTRINE
Riparian Doctrine
Used in Eastern States:
States east of the 100th Meridian.
Humid Region
Reasonable Use (do not harm neighbors)
SURFACE WATER
Prior Appropriations Doctrine:
Think Western U.S. & Rivers
Water is measured in Acre-Feet in the U.S.
SURFACE WATER
QG-Where did the Prior Appropriations Doctrine develop?
Limited and Variable Supply (Western U.S)
Price
(0,0) Quantity
PRIOR
APPROPRIATIONS
Used in 17 Western States:
States west of the 100th Meridian.
Arid Region
Seniority of right is important:

Sometimes only a few appropriators receive water
Problems with return flows

Consumptive use & non-consumptive use
SURFACE WATER
QH- What is a frontier tenure regime?
A regime that requires people to
use a resource before claiming
title to the resource
PriorAppropriations Doctrine is
a frontier tenure regime
SURFACE WATER
use
externalities
groundwater
INTRODUCTION
Inter-temporal groundwater allocation is similar
to fossil fuels, although aquifers may recharge.
Groundwater can be a renewable resource

given the possibility of recharge, but may
effectively be an exhaustible resource when
recharge is low or zero
Withdrawals from aquifers in this country are

dramatically exceeding recharge.
GROUNDWATER
QI - Why is open access a problem?
Open access is when any one can use a resource,
i.e., there is no excludability
There is entry until marginal private benefits

equal marginal private costs
Marginal social costs of entry are ignored
Open access dissipates scarcity rent--

which is inefficient.
CONGESTION
Property rights problem: open access
Any one can exploit the aquifer.
Aquifer
GROUNDWATER
Bath tube or segmented aquifer?
Aquifer
GROUNDWATER
QJ What is the difference between Open
Access and Common property?
Economists distinguish between open
access and common property
Open accessany one can use the
resource, i.e. there is no excludabilty
Common propertyonly members can
use the resource, i.e., non-members can
be excluded
CONGESTION
Mondays Highlights
Natural Monopoly
Allocation of Surface Water
Riparian Doctrine
Open-Access and a Commons
INTRODUCTION
Todays Plan
INTRODUCTION
Mar 1 Groundwater
Mar 3D Discuss HW #5 Water
Resource Economics
Mar 4 HW #5 Water
Resource
Economics
Mar 6 Fisheries F6 Fisheries Q6 Fisheries
Economics Economics
Mar 8 Fisheries
Resource Economics
Discuss HW #6
Fisheries Economics
Economics
Mar 13 Fisheries Economics F7 Forest Q7 Forest
Economics Economics
INTRODUCTION
Announcements
Posted
Exam returned not sure on date yetwill make an

announcement on the compass webpage when it
becomes clearer
INTRODUCTION
use
externalities
groundwater
INTRODUCTION
QJ What is the difference between Open
Access and Common property?
Economists distinguish between open
access and common property
Open accessany one can use the
resource, i.e. there is no excludabilty
Common propertyonly members can
use the resource, i.e., non-members can
be excluded
CONGESTION
QK What is the objective for aquifer management?
Pick the depletion/use path that maximizes the
NPV of the aquifer.
NPV of an aquifer is equivalent to scarcity

rentsince the water in the aquifer is provided
without cost
Need joint arrangements to efficiently exploit

an open access resource to maximize scarcity
rent/NPV.
OBJECTIVE
Costs & Benefits of Groundwater Use
Time 0 1 2 ... t ...
Benefits P0W0 P1W1 P2W2 ... PtWt ...
Costs c(S0)W0 c(S1)W1 c(S2)W2 ... c(St)Wt ...
Net Benefits [P0 -c(S0)]W0 [P1 -c(S1)]W1 [P2 -c(S2)]W2 ... [Pt -c(St)]Wt ...
Variables:
c(St) - marginal extraction costs at stock level, St
pt - water price (or marginal value) at time t
r - discount rate
Wt - withdrawal at time t
GROUNDWATER
QL1 What is the (discrete time) objective function that
maximizes the NPV/scarcity rent of an aquifer?
1 (1 ) 1
= 0 (0 ) 0 +
. . . 1+
( ) ( )
+ ...+ + ...+
(1+) (1+)

( )
=
. . . (1 + )
=0
INTRODUCTION
QL2 What is the (continuous time) objective function
that maximizes the NPV/scarcity rent of an aquifer?
The continuous objective function is:
= ()
. . .
0
Variables:
c(S(t)) - marginal extraction costs at stock level, S(t)
p(t) - water price at time t
r - discount rate
W(t) - withdrawal rate at time t
INTRODUCTION
QM1 What is the (discrete time) State Equation
for an Aquifer?
State Equation (Difference Equation
Discrete time):
St+1 = St Wt + Rt
Rt Recharge at time t
St Stock Size at time t
Wt Withdrawals at time t
STATE EQUATION
QM2 What is the (continuous time) State
Equation for an Aquifer?
State Equation (Differential Equation

Continuous time):
dS(t)/dt = R(t) W(t)
R(t) Recharge rate at time t
S(t) Stock Size at time t
W(t) Withdrawal rate at time t
STATE EQUATION
Non-negativity constraints & initial stock
Non-negativity constraints:
For every time t, Wt and St 0 or W(t) and S(t) 0
Assume we know the initial stock, S(0) = S0.
GROUNDWATER
QN What is the complete aquifer problem?
Maximize N [ pt c ( St )]Wt
Objective Function: (1 r )t
w.r.t.Wt t 0
State Equation (Difference Equation): St+1 = St Wt + Rt
Non-negativity constraints: For all t, Wt and St 0
Initial stock: S(0) = S0.
SUMMARY
Wednesdays Highlights
INTRODUCTION
Todays Plan
Finish groundwater
Why study fisheries
Fisheries growth
INTRODUCTION
Quiz (Due on Homework Assignment
Date Topic Reading Assignment Monday; see quiz for (Due at Noon on
exact time) Saturday)
Mar 6 Fisheries F6 Fisheries Economics Q6 Fisheries
Economics
Mar 8 Fisheries
Resource Economics
Discuss HW #6 Fisheries
Economics
Economics
Mar 13 Fisheries Economics F7 Forest Economics Q7 Forest Economics
SPRING BREAK
Mar 31D Review HW #6 Fisheries
Economics
Discuss HW #7 Forest
Economics
Apr 1 HW #7 Forest Economics
Apr 3 Review HW #7 Forest
Economics
Exam II Review
April 4 Review Session
Apr 5 Exam II
Apr 7D Land Economics
INTRODUCTION
Announcements
Posted Soon
Exam returned today
INTRODUCTION
use
externalities
Be able to characterize optimal
behavior to use groundwater
INTRODUCTION
QN What is the complete aquifer problem?
Maximize N [ pt c ( St )]Wt
Objective Function: (1 r )t
w.r.t.Wt t 0
State Equation (Difference Equation): St+1 = St Wt + Rt
Non-negativity constraints: For all t, Wt and St 0
Initial stock: S(0) = S0.
SUMMARY
QO -How is groundwater use characterized?
Path and/or Steady-State
Steady-State:
Stock size is constant every period, and withdrawals at
time t equals recharge at time t
St+1 = St which implies Wt = Rt
Path: Range of Answers
STEADY STATE &

PATH
Aquifer Depletion (No Recharge)
Objective is to pick the best depletion path
X0
Stock
(0,0) N Time
OPTIMAL PATH
Aquifer Depletion (With Recharge):
Example Path & Steady-State
S(0)
Stock
(0,0) Path Steady-State Time
Optimal Path &

Steady State
Learning Objectives this section
Be able to identify different types of fisheries
growth
Be able to completely describe the logistic growth
in terms of graphs and difference equations
Be able to state a fisheries objective function for
both the dynamic path and steady-state
Be able to completely describe steady states for
the logistic growth functions using graphs
Be able to critique major types of fisheries
regulation
Be able to determine when marine reserves might
increase harvests
LEARNING
OBJECTIVES
QP- Why study fisheries economics?
Motivation for studying fisheries
Important resource
Likely to encounter as resource
professionals or citizens
Open-access problem is important
MOTIVATION
Characterization of marine resources
Fisheries are usually open-access resources
(congestion externalities)
Fisheries are renewable resources which grow --

more difficulty to model than exhaustible
resources
MOTIVATION
QQ - How do fish stocks grow?
Three common types of assumed growth:
Lumped parameter or biomass only (Logistic
growth; intraspecific competition)
Age Cohort (not covered)
Space Constrained
Focus on biomass of freshwater or marine

fisheries.
FISH GROWTH
Mondays Highlights
Finish groundwater
Why study fisheries
Fisheries growth
Exam Review
INTRODUCTION
Todays Plan
Fisheries growth
Logistic growth
Critical depensation
Space constrained
Objective function
INTRODUCTION
Quiz (Due on Homework Assignment
Date Topic Reading Assignment Monday; see quiz for (Due at Noon on
exact time) Saturday)
Mar 8 Fisheries
Resource Economics
Discuss HW #6 Fisheries
Economics
Economics
Mar 13 Fisheries Economics F7 Forest Economics Q7 Forest Economics
SPRING BREAK
Mar 31D Review HW #6 Fisheries
Economics
Economics
Apr 1 HW #7 Forest Economics
Economics
Exam II Review
Apr 5 Exam II
INTRODUCTION
Announcements
Posted Soon
INTRODUCTION
growth
regulation
increase harvests
LEARNING
OBJECTIVES
QQ - How do fish stocks grow?
Three common types of assumed growth:
Lumped parameter or biomass only (Logistic
growth; intraspecific competition)
Age Cohort (not covered)
Space Constrained
Focus on biomass of freshwater or marine

fisheries.
FISH GROWTH
Tool #6: Logistic Growth Equation
Xt+1 = Xt + mXt - mXt2/K
or
dX(t)/dt = mX(t)-mX(t)2/K = mX(t)(1-X(t)/K)
Parameters
K - carrying capacity for stock
m - natural rate of increase - (with no crowding)
mXt2/K or mX(t)2/K- crowding effect
Xt or X(t)- stock size at time t
dX(t)/dt = change in stock size at time t
LUMPED
PARAMETER
Logistic Growth
Growth
mK/4
(0,0) K/2 K
Stock Size
LUMPED
PARAMETER
Logistic Growth Over Time Without
Harvest
Stock
Size
K
(0,0) Time
LUMPED
PARAMETER
Logistic Style Growth with
Critical Depensation
Growth
(0,0) K
Stock Size
DEPENSATION
Logistic Growth Over Time Without
Harvest with Critical Depensation
Stock
Size
K
(0,0) Time
DEPENSATION
Space Limited Growth
Second type of growth model-- age cohorts
Third type of growth modelspace limited
Example: Lobster Bed
SPACE
CONSTRAINED
QR What are the possible costs and benefits
from fishing?
Time 0 1 2 ... t ...
Benefits p0h(E0,X0) p1h(E1,X1) p2h(E2,X2) ... pth(Et,Xt) ...
Costs wE0 wE1 wE2 ... wEt ...
Net Benefits p0h(E0,X0)-wE0 p1h(E1,X1)-wE1 p2h(E2,X2)-wE2 ... pth(Et,Xt)-wEt ...
Variables:
Et fishing effort at the time
h( . ) harvest
pt fish price at time t
w marginal cost of fishing effort
Xt stock size at time t
FISHING BENEFITS
AND COSTS
QS What is the objective function for a fishery?
The objective is:
Maximize N
pth( Et , Xt ) wEt
NPV
Et t 0 (1 r ) t
Variables:
Et fishing effort at time t
h(Et,Xt) harvest at time t
r discount rate
OBJECTIVE
QT- What is a steady-state for Logistic Growth?
Same population, effort and harvest each period
Xt+1-Xt = [dX(t)/dt] = 0 which implies
mXt(1-Xt/K) = h(Et,Xt) [Growth = harvest]
where h(Et,Xt) is the harvest function at time t.
In steady state notation, we can write:

Xt+1-Xt = X-X = 0 which implies
mX(1-X/K) = h(E,X) [Growth = harvest]
where E and X are steady-state values
STEADY STATES
QU Why do we focus on steady-states in
a fishery?
Steady-states are much easier to
analyze than a dynamic path.
STEADY-STATES
Graph of logistic growth steady states
Growth =
Harvest
(0,0) K
Stock Size
OPTIMAL
HARVESTING
Fisheries growth
Logistic growth
Critical depensation
Space constrained
Objective function
INTRODUCTION
Todays Plans
Objective function
Key steady-states
Fisheries regulation
Season closures & gear restrictions

Privatization of a fishery
INTRODUCTION
Quiz (Due on Homework
Date Topic Reading Assignment Monday; see quiz Assignment (Due at
for exact time) Noon on Saturday)
Mar 13 Fisheries Economics F7 Forest Economics Q7 Forest
Economics
Mar NO CLASS NO CLASS NO CLASS
17D
SPRING BREAK
Mar Review HW #6 Fisheries
31D Economics
Economics
Apr 1 HW #7 Forest
Economics
Economics
Exam II Review
Apr 5 Exam II
INTRODUCTION
growth
regulation
increase harvests
LEARNING
OBJECTIVES
QS What is the objective function for a fishery?
The objective is:
Maximize N
pth( Et , Xt ) wEt
NPV
Et t 0 (1 r ) t
Variables:
Et fishing effort at time t
h(Et,Xt) harvest at time t
r discount rate
OBJECTIVE
FUNCTION
QT- What is a steady-state for Logistic Growth?
Same population, effort and harvest each period
Xt+1-Xt = [dX(t)/dt] = 0 which implies
mXt(1-Xt/K) = h(Et,Xt) [Growth = harvest]
where h(Et,Xt) is the harvest function at time t.
In steady state notation, we can write:

Xt+1-Xt = X-X = 0 which implies
mX(1-X/K) = h(E,X) [Growth = harvest]
where E and X are steady-state values
STEADY STATES
QU Why do we focus on steady-states in
a fishery?
Steady-states are much easier to
analyze than a dynamic path.
STEADY-STATES
Graph of logistic growth steady states
Growth =
Harvest
(0,0) K
Stock Size
OPTIMAL
HARVESTING
QW What are three important steady-states
for a fishery?
Biological Maximum
MSYMaximum Sustainable Yield
Economic Maximum
MEYMaximum Economic Yield (Rent-
Maximizing)
No Criteria
OAOpen Access
STEADY STATES
Graph of the MSY Steady State with
Logistic Growth?
Growth =
Harvest
mK/4
(0,0) K/2 K
Stock Size
OPTIMAL
HARVESTING
Graph of the MSY Steady State with
Logistic Growth?
Growth =
Harvest
mK/4
(0,0) EMEY
Harvesting Effort
OPTIMAL
HARVESTING
QX What are important problems with
MSY?
Problems:
potential for fisheries collapse
no costs and revenues
Partial Solution:
Introduce costs and revenues
OPTIMAL
HARVESTING
Open Access and Rent Maximizing Steady-
States
$
P*Growth =
p*Harvest
TC
TR
(0,0) EMEY EOA

Harvesting Effort
OPTIMAL
HARVESTING
Open Access and Rent Maximizing Steady-
States
$
P*Growth =
p*Harvest
TC
TR
(0,0) XOA XMEY K

Stock Size
OPTIMAL
HARVESTING
QY Why is EMEY less than EMSY?
Increasing harvesting effort in any
period increases harvesting in that
period, but reduces the stock of fish in
the future, i.e., there is a user cost for
harvesting fish.
In the steady rent-maximizing requires

less harvesting effort trying to harvest
from a stock with greater biomass.
SUSTAINABLE
FISHING
QZ What is the economic purpose of
regulating fisheries?
To move from OA to MEY by restricting catch
or effort in an economically efficiently manner.
(Alterative wording) To move from the open

access level of harvesting effort to the rent
maximizing level of harvesting effort without
unnecessarily increasing harvesting costs.
INTRODUCTION
Types of Regulation
Gear Restrictions and Season
Closings
Privatization of Fisheries
transferable catch permits
Taxes
REGULATION
Normative Questions
Which types of regulations are

economically efficient?
How is equity addressed?
REGULATION
1) Gear Restrictions & Season Closings
$ TC1
p*Growth =
p*Harvest
TC0
TR
(0,0) EMEY EOA

Harvesting Effort
REGULATION
1) Gear Restrictions & Season Closings
$
TC1
p*Growth =
p*Harvest TC0
TR
(0,0) XOA XMEY K

Stock Size
REGULATION
QAA Can Gear Restrictions & Season
Closings achieve policy goals?
Can biological objectives be achieved?
Yes
Can the policy be economically efficient?

No
When is the policy equitable?

Most scenarios
REGULATION
2) Privatize Fisheries transferable catch permits
p*Growth =
p*Harvest
TC
TR
(0,0) EMEY EOA

Harvesting Effort
REGULATION
2) Privatize Fisheries transferable catch permits
p*Growth =
p*Harvest TC
TR
(0,0) XOA XMEY K

Stock Size
REGULATION
QBB Can privatizing fisheries achieve policy
goals?
Yes

Yes

Government sells to highest bidder
Random distribution
REGULATION
Mondays Highlights
Objective function
Key steady-states
Season closures & gear restrictions

Privatization of a fishery
INTRODUCTION
Todays Plans
Tax on effort
Tax on catch
Marine reserves
Forest Growth
INTRODUCTION
Mar NO CLASS NO CLASS NO CLASS
17D
SPRING BREAK
31D Economics
Economics
Apr 1 HW #7 Forest
Economics
Economics
Exam II Review
Apr 5 Exam II
INTRODUCTION
growth
regulation
increase harvests
LEARNING
OBJECTIVES
3a) Tax on Effort
$ Maximum Rent
EMEY
p*Growth =
p*Harvest
TC
Tax
TR
(0,0) EMEY EOA

Harvesting Effort
REGULATION
3a) Tax on Effort
$ Maximum Rent
EMEY
p*Growth =
p*Harvest TC
Tax
TR
(0,0) XOA XMEY K

Stock Size
REGULATION
QCC1 Can a tax on harvesting effort
achieve policy goals?
Yes

Yes (per unit effort tax = maximum rent/EMEY)

Most scenarios
REGULATION
3b) Tax on Catch Maximum Rent
Harvest at EMEY
p*Growth =
p*Harvest
TC
Tax
TR
(0,0) EMEY EOA

Harvesting Effort
REGULATION
3b) Tax on Catch
$ Maximum Rent
Harvest at EMEY
p*Growth =
p*Harvest TC
Tax
TR
(0,0) XOA XMEY K

Stock Size
REGULATION
QCC2 Can a tax on catch achieve policy
goals?
Yes

Yes (per unit catch tax =
maximum rent/optimal catch)

Most scenarios
REGULATION
Marine Reserves
RESERVES
Marine Reserves
Do Marine Reserves increase harvests?
Maybe for a few species
Species specificsee life cycle of fish
Cheap enforcement
Marine reserves usually enhance biological

productivity and often enhance biodiversity
REGULATION
QDD What are the necessary life cycle
characteristics for marine reserves to possible
increase harvests?
Exponential Fecundity
Larval Mixing
Small Adult Home Range
REGULATION
QEE Can marine reserves achieve policy goals?
Yes

Maybe if conditions on previous slide are met

Most scenarios
REGULATION
Learning Objectives for forestry section
Be able to write objective functions for simple
single rotation models and infinite rotation
models
Be able to apply harvest rules for simple single

rotation models and infinite rotation models
Be able to answer a range of non-rotation

forest economics questions
LEARNING
OBJECTIVES
QFF1- What is the fundamental question in forest
economics and management?
When is the best age/time to cut a tree
or stand of trees?
QFF2-How do we answer this question?

We develop harvest rules.
FOREST ECONOMICS
QGG-How do we encourage non-industrial private
landowners to regenerate and manage their forest land?
Regeneration & management subsidies

Tax incentives
FOREST ECONOMICS
Develop Harvest Rules
Our goal is to develop harvest rules
We focus on the easy case of even-age management

for stands
Models:
Biological MAI (MSY)
Economic Models
Single Rotation
Single Rotation with Land Valued
Land/Asset Sale
Land Rents
Infinite Rotation
Infinite Rotation with Amenity Values
FOREST ECONOMICS
Tax on effort
Tax on catch
Marine reserves
Forest Growth
INTRODUCTION
Biological Model
Single Rotation Model
INTRODUCTION
31D Economics
Economics
Apr 1 HW #7 Forest
Economics
Economics
Exam II Review

Apr 5 Exam II
Apr 10 Land Economics F8 Land & Agricultural Q8 Land &
Economics Agricultural
Economics
Apr 12 Agricultural Economics
Apr 14D Discuss HW #8 Land &
Agricultural Economics
INTRODUCTION
Announcements
Homework Assignment 7 posted soon
Review Session on April 4th at 8pm in 103

Mumford Hall
Exam on April 5th in class
Exam Review Guide Posted later this week

(Questions presented in lectures, e.g., QA,
QB . . .)
INTRODUCTION
models


LEARNING
OBJECTIVES
QFF1- What is the fundamental question in forest
economics and management?
When is the best age/time to cut a tree
or stand of trees?
QFF2-How do we answer this question?

We develop harvest rules.
FOREST ECONOMICS
Develop Harvest Rules
Our goal is to develop harvest rules
We focus on the easy case of even-age management

for stands
Models:
Biological MAI (MSY)
Economic Models
Single Rotation
Single Rotation with Land Valued
Land/Asset Sale
Land Rents
Infinite Rotation
Infinite Rotation with Amenity Values
FOREST ECONOMICS
Biological Model: Infinite Rotations
Volume
(0,0) T 2T Time
Plant Cut & Cut &
Plant Plant
FOREST ECONOMICS
Biological Model: Single Rotation
Volume
(0,0) T Age/Time
Plant Harvest
FOREST ECONOMICS
Biological Model:
MAI or MSY Ray from origin
Volume
(0,0) T* Age/Time
Plant Harvest
FOREST ECONOMICS
QHH What is the objective function for
maximizing the Mean Annual Increment (MSY)?
Objective Function
Y (t ) Maximum V (t ) V (2t ) V (3t )...
w.r.t. t
Alternatively: Objective Function

V (t )
Y (t ) / t Maximum
t
w.r.t. t
where
t - Age
V(t) - Volume Function (Volume at age t)
Y(t) - Total Yield
FOREST ECONOMICS
Mean Annual Increment (MSY)
Take the derivative of the objective function and

set equal to zero
V (t )
Maximize
t
w.r.t. t
Use the Quotient Rule:

V (t ) dV (t )
d t V (t )
Maximize t dt 0
2
dt t
w.r.t. t
FOREST ECONOMICS
Simplify
dV (t ) dV (t ) V (t )
t V (t ) 0;
dt dt t
Marginal Growth = Average Growth
FOREST ECONOMICS
Why does this result make sense?
The growth decreases over time
If the growth (rate) > average

What happens to the average?
If the growth (rate) < average

What happens to the average?
FOREST ECONOMICS
Summary
We want to maximize average volume
If the growth (rate) > average average increases

If the growth (rate) < average average decreases
The growth rate for starts high and is decreasing
We want to cut the trees when growth rate = average

growth
FOREST ECONOMICS
QII What is the harvest rule for maximizing the
Mean Annual Increment (MSY)?
Marginal Growth = Average Growth;
dV(t)/dt = V(t)/t;
This implies:
If Marginal Growth > Average Growth, then age is
less the MAI age, do not harvest

If Marginal Growth < Average Growth, then age is
greater than MAI age, harvest immediately

This formulation does not discount the future, while
economic models discount the future.
FOREST ECONOMICS
Harvest RuleStatement & Meaning
Statement of Rule:
Marginal Revenue from Delaying Harvest =
Marginal Costs from Delaying Harvest
If the Left-hand side > Right-hand side,

(MR from delaying harvest > MC from delaying harvest)
then do not harvest
If the Left-hand side < Right-hand side,

(MR from delaying harvest < MC from delaying harvest)
then harvest immediately
FOREST ECONOMICS
QJJ What are the costs and benefits in the
single rotation model?
Time 0 1 2 ... t t+1 ...
Costs C 0 0 ... 0 0 ...
Benefits 0 0 0 ... pV(t) 0 ...
C - regeneration costs
V(t) stumpage volume as a function of age
p - stumpage price
FOREST ECONOMICS
QKK- What is the objective function for the
The problem is:
pV (t )
Objective NPV (t ) Maximum C
(1 r ) t
w.r.t.t
C, p and r constant over time.

NPV(t) - net present value as a function of age
p - stumpage price
r - discount rate
V(t) stumpage volume as a function of age
Note that we require optimal NPV to be positive, i.e.

there exists a t (an age) such that NPV(t) > 0
FOREST ECONOMICS
QKK- What is the objective function for the
The continuous time version is:
Objective Function
NPV(t) = Maximum e-rtpV(t) C
w.r.t. t
Interpretation: Discounted total revenue minus

regeneration costs
FOREST ECONOMICS
Single Rotation Model:
Volume versus Age/Time

V(t)
(0,0)
Age/Time
FOREST ECONOMICS
Total Revenue versus Age/Time

p*V(t)
(0,0)
Age/Time
FOREST ECONOMICS
Discounting Curves
I2
I1
$ I0
(0,0)
Age/Time
FOREST ECONOMICS
Impose Discounting Curves:
Total Revenue versus Time
I2
I1
$
I0
(0,0) T* Age/Time
FOREST ECONOMICS
Calculus Approach
Take the derivative of the continuous
objective function and set equal to zero.
For economic models, when we

maximize, the results are the first order
conditions.
FOREST ECONOMICS
QLL What is the harvest rule for a single
rotation model?
First statement of Harvest Rule: pV (t ) rpV (t );
Marginal Revenue from Delaying Harvest =
Marginal Costs from Delaying Harvest
Interpretation:
LHS is growth in total revenue (a physical capital gain)
RHS is interest forgone
If the Physical Capital Gain > Interest Forgone; Do not harvest

If the Physical Capital Gain < Interest Forgone; Harvest
FOREST ECONOMICS
Mondays Highligts
Biological Model
INTRODUCTION
Review of Lecture Problem 14
Land Sale Model
Land Rent Model
Infinite Rotation Model
INTRODUCTION
31D Economics
Economics
Apr 1 HW #7 Forest
Economics
Economics
Exam II Review

Apr 5 Exam II
Apr 10 Land Economics F8 Land & Agricultural Q8 Land &
Economics Agricultural
Economics
Apr 12 Agricultural Economics
Apr 14D Discuss HW #8 Land &
Agricultural Economics
INTRODUCTION
Announcements
Homework Assignment 7 posted soon
Review Session on April 4th at 8pm in 103

Mumford Hall
Exam on April 5th in class
Exam Review Guide Posted later this week

(Questions presented in lectures, e.g., QA,
QB . . .)
INTRODUCTION
models


LEARNING
OBJECTIVES
QMM1--What is the problem with the single
rotation model?
It does not account for opportunity

costs of the land.
The other economic models will

incorporate the costs of land.
FOREST ECONOMICS
QMM2--What is the solution to the problem
with the single rotation model?
Solutioninclude the opportunity cost of
land
Opportunity cost of land is modeled in
three ways:
Land/Asset Sale
Land Rents from non-forestry use
Infinite rotation (opportunity cost from

future rotations)
FOREST ECONOMICS
QNN What are the costs and benefits in the
single rotation model with land sale?
Time 0 1 2 ... t t+1 ...
Costs C 0 0 ... 0 0 ...
Benefits 0 0 0 ... pV(t)+A 0 ...
A Land sale price

p - stumpage price
V(t) stumpage volume at age t
FOREST ECONOMICS
QOO What is the objective function for the single
rotation model with land sale?
The objective function is:
pV (t ) 1
NPV (t ) Maximum C A
(1 r ) t
(1 r ) t
w.r.t.t
where A is sale value at the end of the rotation
The continuous time objective function is:
NPV (t ) Maximum e rt pV (t ) C e rt A
w.r.t.t
FOREST ECONOMICS

V(t)
(0,0)
Age/Time
FOREST ECONOMICS
Total Revenue Versus Age/Time
p*V(t)
(0,0)
Age/Time
FOREST ECONOMICS
Land Value versus Age/Time
$A
(0,0)
Age/Time
FOREST ECONOMICS
Sum of Total Revenue & Land Value
$ A
(0,0)
Age/Time
FOREST ECONOMICS
Sum of Total revenue & Land Value
with Discounting Curves
I2
I1
I0
(0,0) T* Age/Time
FOREST ECONOMICS
QPP What is the harvest rule for a single rotation
model with land sale?
Statement of Rule:
Marginal Revenue of Delay = Marginal Costs of Delay
Harvest Rule in symbols pV (t ) rPV (t ) rA
Interpretation:
RHS is interest forgone on both harvest revenue and land value
Note: Harvest will occur at an earlier age than without

land sale
FOREST ECONOMICS
QQQ What are the costs and benefits in the
single rotation model with land rents?
Time 0 1 2 ... t t+1 ...
Costs C+W W W ... W 0 ...
Benefits 0 0 0 ... pV(t) 0 ...
p - stumpage price
W per period land rent
FOREST ECONOMICS
QRR- What is the objective function for the single
rotation model with land rents?

t
pV (t ) 1
NPV (t )
Maximum
(1 r ) t
C
s 0 (1 r )
s
W
w.r.t.t
where W is per period land rent

Maximum rt t
NPV (t ) e pV (t ) C e rs wds
w.r.t.t 0
where w is the land rent rate.

FOREST ECONOMICS
V(t)
(0,0)
Age/Time
FOREST ECONOMICS
Total Revenue versus Age/Time
p*V(t)
(0,0)
Age/Time
FOREST ECONOMICS
Cumulative Undiscounted Land Rents
$
W * time
(0,0)
Age/Time
FOREST ECONOMICS
Cumulative Undiscounted
and Discounted Land Rents
$
W * time
(0,0)
Age/Time
FOREST ECONOMICS
Total Revenue minus land rents versus Age
$
(0,0)
Age/Time
FOREST ECONOMICS
Single Rotation Model with Land Rents:
Maximizing NPV
$
I2
I1
I0
(0,0) T* Age/Time
Note that NPV may be much lower with land rents
FOREST ECONOMICS
QSS What is the harvest rule for a single rotation
model with land rents?
First Statement of Rule:
Marginal Revenue of Delay =
Marginal Costs of Delay
Harvest Rule in symbols pV (t ) rpV (t ) W

Interpretation:
RHS is interest forgone plus land rents paid
Note: If land markets are efficient, then harvest will occur at the
same age as the single rotation with land sale and infinite rotation
models
FOREST ECONOMICS
QSS What is the harvest rule for a single rotation
model with land rents?
Second Statement of Rule:
Growth rate = Discount rate plus a positive constant
Harvest Rule in symbols V (t ) W

r
V (t ) pV (t )
Interpretation:
LHS is growth rate
RHS is the discount rate plus the ratio of land rent

to total revenue
FOREST ECONOMICS
Biological Model (Maximum Sustained Yield)
V(t) = V(t)/t;
V (t )
pV (t ) rpV (t ); V (t ) rV (t ); r;
V (t )
Asset Sale Single Rotation Model
pV (t ) rpV (t ) rA ;
Asset Sale Single Rotation Model with Land

Rents
V (t ) W
pV (t ) rpV (t ) W ; r ;
V (t ) pV (t )
FOREST ECONOMICS
Infinite Rotation: Original Faustmann Model
Volume
(0,0) T 2T Time
Plant Cut & Cut &
Re-plant Re-plant
FOREST ECONOMICS
Forest Economics
QTT What are the costs and benefits in the
infinite rotation model?
Time 0 1 2 ... t t+1 ...
Costs C 0 0 ... C 0 ...
Benefits 0 0 0 ... pV(t) 0 ...
Time 2t 2t+1 ... 3t 3t+1 ... 4t

Cost C 0 ... C 0 ... C
Benefits pV(t) 0 ... pV(t) 0 ... pV(t)
p - stumpage price
FOREST ECONOMICS
Infinite Rotation Model
Unlike the biological or single rotation

models:
There is no easy graphical solution
There is no easy analytical approach
Still need to assume there exists an age t,

such that NPV(t) > 0
FOREST ECONOMICS
Forest Economics
QUU- What is the objective function for the infinite
rotation model ?

pV (t ) 1 pV (t )
NPV (t ) (1 r )t C (1 r )t (1 r )t C

1 2 pV (t )
1 pV (t )
3

t
C
t
C
(1 r ) (1 r ) (1 r ) (1 r )
t t

1 4 pV (t )

t
C ...
(1 r ) (1 r )
t

Same definitions as before
FOREST ECONOMICS
Forest Economics
Infinite Rotation Problem
Note that NPV is a geometric series
pV (t )
NPV (t ) C (1 a a 2
a 3
a 4
...)
(1 r )
t

1
where a
t
(1 r )
After some algebra, we have

pV (t )
C
(1 r ) t
Single Rotation Pr oblem
NPV (t )
1 Infinite Rotation Factor
1
(1 r ) t
FOREST ECONOMICS
Forest Economics
QUU- What is the objective function for the infinite
rotation model ?
e rt pV (t ) C Single Rotation Pr oblem
NPV (t )
1 e rt
Infinite Rotation Factor
The first-order condition is found by

differentiating the continuous time version with
respect to t
After more algebra, we have can derive a harvest

rule
FOREST
Forest ECONOMICS
Economics
QVV What is the harvest rule for the
infinite rotation model?
Statement of Rule:
Marginal Revenue of Delay = Marginal Costs of Delay
Harvest Rule in symbols

physical capital gain
pV (t ) C = interest forgone on current
pV (t ) r rt
1 e and future rotations
Compare to Single Rotation with Land Rents Model

pV (t ) rpV (t ) w physical capital gain
= interest forgone + land rent
FOREST
Forest ECONOMICS
Economics
Comparison with single rotation with land rents
Also equivalent to the land sale model
physical capital gain
pV (t ) rPV (t ) rA = interest forgone + land rents
w e rt pV (t ) C
If land markets work then A
r 1 e rt
Interpretations are the same:

RHS is interest forgone plus land rents paid
Faustmann Formula
Land rents arise from future rotations
FOREST ECONOMICS
Forest Economics

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Todays plan of action

Exam return--not sure on date yet

low variable costs

declining average costs

Travel Infrastructure (air, auto, rail)

Cable (Computer, TV)

(0,0) QATC QMC Q

Prior Appropriations Doctrine:

Reasonable Use (do not harm neighbors)

Water is measured in Acre-Feet in the U.S.

Seniority of right is important:

Problems with return flows

Groundwater can be a renewable resource

Withdrawals from aquifers in this country are

There is entry until marginal private benefits

Marginal social costs of entry are ignored

Open access dissipates scarcity rent--

Open-Access and a Commons

Exam returned not sure on date yetwill make an

NPV of an aquifer is equivalent to scarcity

Need joint arrangements to efficiently exploit

St Stock Size at time t

State Equation (Differential Equation

Assume we know the initial stock, S(0) = S0.

State Equation (Difference Equation): St+1 = St Wt + Rt

Non-negativity constraints: For all t, Wt and St 0

Initial stock: S(0) = S0.

Exam returned today

State Equation (Difference Equation): St+1 = St Wt + Rt

Non-negativity constraints: For all t, Wt and St 0

Initial stock: S(0) = S0.

Path: Range of Answers

STEADY STATE &

(0,0) Path Steady-State Time

Optimal Path &

Fisheries are renewable resources which grow --

Focus on biomass of freshwater or marine

Focus on biomass of freshwater or marine

In steady state notation, we can write:

Season closures & gear restrictions

In steady state notation, we can write:

no costs and revenues

(0,0) EMEY EOA

(0,0) XOA XMEY K

In the steady rent-maximizing requires

(Alterative wording) To move from the open

Which types of regulations are

How is equity addressed?

(0,0) EMEY EOA

(0,0) XOA XMEY K

Can the policy be economically efficient?

When is the policy equitable?

(0,0) EMEY EOA

(0,0) XOA XMEY K

Can the policy be economically efficient?

When is the policy equitable?

Season closures & gear restrictions

(0,0) EMEY EOA

(0,0) XOA XMEY K

Can the policy be economically efficient?

When is the policy equitable?

(0,0) EMEY EOA

(0,0) XOA XMEY K

Can the policy be economically efficient?