You can't take it with you. A private owner of a natural resource, like a forest, therefore, will want to clear-cut the forest before he dies in order to maximize his consumption stream (assume the owner has no children or other bequest motive). True or False. Explain.A George Mason professor provides the answer as follows:
False. The owner can sell the forest. As a result, the owner of a forest has an incentive to continue to seed it even if seeds planted today won't produce trees until after the owner is dead. The same idea applies to any long-lived productive asset. I think this insight is very beautiful. It's precisely the fact that the forest is owned that gives the owner an incentive to take into account how other people value the forest.I think I understand why the author chose a natural resource like a forest to illustrate the principle he was trying to get across (because it's tragic when forests are cut down! [pub -- he's expressing his sincere feelings here]), but I don't think it's the best choice of example for this question.
The basic logic doesn't require perfect competition or fully efficient markets but if these assumptions do hold then the private owner will choose investment decisions exactly as would a "social planner."
But first, there's an interesting aside to this question that I want to ask: does the logic imply that the forest will always be reseeded in the interests of enhancing its value to the next owner, or will it eventually be cut down by one of its owners? This has important consequences because no one likes it when forests are destroyed! (pub -- better - much more convincing.) I think the answer is that the forest will eventually be clear-cut by an owner, or in other words, there exists a circumstance in which the owner has incentive to clear-cut the forest rather than maintain it. Here's why I think this is:
The essential insight of the answer is that the value of the forest to the owner equals its value on the market (or to the highest bidder among future owners of the forest). Since future owners will be able to produce much more profit out of the forest over the course of their lives than an owner near the end of his life will, it will be worth more to them than to the owner, and thus the owner has an incentive to maintain the forest rather than harvest it for his own profit. Normally, the productive potential of the forest to a future owner will be greater than the actual saleable value of the forest to the current owner who has limited time left in which to transform the forest's product into profits.
But say that its value on the market is declining because, say, the demand for houses has decreased (there will be a natural delay between a decline in the demand for wood and a decline in the value of the forest because of imperfect information and the time it takes information to be transmitted). If the rate of decline in the value of the product of the forest is sufficiently great, and is expected to stay that level for the lifetime of the next generation of owners, the profit to be derived from harvesting the entire forest right now will be greater than the potential profitability of the forest to the future owner (or arbitrageurs or series of arbitrageurs, etc.) This makes sense because:
1) It takes time for the purchase to be completed and for the forest to change owners, time during which the value of the forest will further decline.
2) A steadily declining value for the forest takes away a major incentive for purchasing it: that is purchasing it for its continued profitability over an extended period of time.
Put another way, if the forest's greatest value is projected to be the value of its produce right now, why would anyone want to purchase it?
Such an answer assumes that long-term information is not perfect, which is a realistic assumption for the real world I think. If long-term information were perfect (long-term meaning for the purposes of this problem: knowledge of the future value of the forest beyond the lifespan of a single owner), then arbitrageurs would be willing to buy the forest in the intermediate term, even when the price is declining rapidly, with the aim of selling the forest back to forest industry people when demand for wood goes back up. I'm assuming that this is not possible, so that when the profitability of having a forest goes down, people assume that it's going to be down for the forseeable future, and are unwilling to pay higher for it than its current profit potential. Is this a reasonable assumption? I'm not sure, but I would think that 40 years or so is a reasonable span of time beyond which future demand for a product and market conditions would not be predictable.
So all this would suggest that, in the cold world of profit-maximizing forest owners, the will come a time when every forest is leveled. It's interesting to note that the forest is clear-cut when demand for wood goes down. Just something to think about...
Now back to the original reason for the post: I wanted to take issue with the professor's assertion that "the private owner will choose investment decisions exactly as would a 'social planner'." As I said before, I can understand why the creator of the question chose a forest as the asset, but in particular with a forest, I think, the market outcome will not be the same as the socially optimal outcome.
If the asset was, say, a stock of tree seedlings, and the choice was between preserving them and using them to spawn more tree seedlings, and selling them to nurseries, then it's true that the investment decisions of the owner will coincide exactly with what a social planner would do. But a forest is different because one of the principal benefits of the forest, recreation, is enjoyed by people who are not in the market for purchasing forests. Thus a large part of the social utility of forests is not represented by the price of the forest. I suppose you could construct a reality in which private owners of the forest also charge admission to individuals, but that's a stretch. Thus, the behavior of owners of the forest will only represent the interests of other potential-owners of the forest, which is a small segment of the people who have a use for the forest. Additionally, a forest has environmental value, which will be ignored by the decisions of profit-driven owners. So I don't think the market for forests is a particularly good example of socially-optimal market outcomes.
Ok, enough of this post. It's time for me to do real academics.
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