Dilemma of attractive interest and time value of money

One of my colleague is being offered 12% interest rate in an account on yearly basis by NMB, while at present a financing firm has provided 10% interest rate on quarterly basis for the deposit. S/he is thinking to withdraw money and deposit the amount at NMB. Based on the skill that has been taught in the previous sessions, What would you suggest, if you were her/his financial adviser ?

Future Value of Multiple Cash Flows

• In many instances, we may be interested in the future value of series of payments of different amounts at different time periods. In such cases, we can find the FV as illustrated below:

Example:

A person deposits $1000, $2000, $3000, $4000 and $5000 at the end of each of the 5 respective years. The interest rate is 10%, compounded annually. Find the future value.

Future value of Multiple Cash Flow

Production of renewable natural resource

Global whale catches

Concept of renewable natural resources

Growth curve for fisheries

Equilibria under various management regimes:Privatization

Open access

Common property

Global Whale Catches 1910-87

Population of whale in a hypothetical situation

0

50000

100000

150000

200000

250000

300000

350000

400000

Glo

bal

catc

hes

1910

-19

1930

-39

1950

-59

1970

-79

Logistic growth curve

Decade growth curve

Production of renewable natural resource

Natural resources may be divided into renewable and non-renewable resources. Non renewable resources, as the name implies, are finite, so that using them all depletes the stock over time. The economic issue with non-renewable resources is the rate at which the stock should run down over time. Renewable resources are capable of regeneration. Example would be fisheries and forestry. Their capacities for self-renewable does not, however, mean that they will, in fact, renew themselves. This depends on the management regime.

Production of renewable natural resource contd..

A forest that is clear-felled and then used for livestock, say, does not typically renew itself (Hamburger connections). Even if the agricultural use is temporary, renewable may be impaired because the soil is eroded and nutrients are lost. A management regime that involves sustainable use allows the resource to renew itself and takes the sustainable yield of the resource. Thus, a fish stock can be fished by harvesting only the mature fish and leaving younger fish to age and breed and grow until they are ready for the next catch. If more than the sustainable yield is taken on a regular basis, the remaining stock has no chance to regenerate. The result is over use, which threatens the resource with extinction.

Production of renewable natural resource contd..

Extinction may be optimal in some circumstances, but extinguishing a renewable resource conflicts, at least potentially, with the philosophy of sustainable development. The economic issue with renewable resources, then, is the rate at which they should be used so that their stocks are maintained.

Resources that yield a constant flow of services through time, such as solar radiation or tidal or wave energy, are sometimes referred to as renewable resources. But this session confines itself to biologically renewable resources.

Growth curve for renewable resource: the fishery

B

A

Xmin

Xmax

C

Fish multiply rapidly

Compete for food

Carrying capacity

Xo Time

Stock (X)

Growth curve for renewable resource: the fishery

Stock (x)

Rate of growth ô

MSY

One apparently obvious management solution is to choose the Maximum Sustainable Yield (MSY). Looks attractive because we can take the MSY each fishing period, leaving stock to regenerate in between and such a policy produces the highest possible catch. Even though many resource managers continue to look for MSY, MSY is, invariably, not the optimal economic policy.

Figure-1.1: Equilibria in the fishery under various management regimes

TC =W*E

Emax

TR = P*H

HPROF

HOA

EOAEPROF

Revenue and Costs

Effort

• The above figure (Figure 1.1) repeats the earlier diagram but changes the horizontal axis to effort. Effort is a measure of the fishing inputs-applied to the resource and could be measured in man-days, number of trawlers, and so forth. The vertical axis is in terms of revenue and costs.

• The intuition is that higher levels of effort correspond to lower levels of stock and the lower levels of effort correspond to higher levels of stock. This the stock decreases as we move along the effort axis.

• Emax now corresponds to maximum effort and hence zero stocks (x0).

• We can convert the yield curve to a total revenue curve by assuming that each ton of the fish harvested commands the same price. Then, harvest, H, times price, P, is total revenue.

• The yield curve becomes a total revenue curve, TR = P*H. • We can also superimpose a total cost curve bu assuming that

each unit of effort, E, commands the same price, W. Then W*E is a total cost curve.

• Two equilibria are of interest. First, suppose the fishery is owned by a single owner.

• This single owner will aim to maximize profits, and this will occur at EPROF where the difference between TR and TC is at a maximum. Note that EPROF does not correspond to the point of maximum sustainable yield. It would do this only if costs were zero. EPROF also looks fairly safe, at least for fish stocks. The equilibrium is a long way from Emax, which suggests that vesting ownership of a resource in an individual may well secure the conservation of that resource. This conclusion will have to be modified when time is more explicitly considered, but it does not suggest one way of securing resource conservation. Notice also that it contrasts starkly with the view that private ownership necessarily leads to resource extinction.

• Second, suppose that there is no single owner and that any anyone and everyone can come and get what they want. This is the case if the fishery is in the high seas, where territorial rights do not exist. Such resources are known as open-access resources: there are no defined owners and no rules for using the resource. In the case of open access, everyone who realizes a profit by entering the fishery does so. Accordingly, wherever TR is above TC, new entrants come to harvest the resource. They stop only when TC exceeds TR, as it does to the right of Eoa in the above figure. Accordingly, Eoa is the open open-access equilibrium.

• Notice that Eoa does not result in the extinction of the resource. Nonetheless, Eoa is quite close to EMax . Essentially, the lower the cost of harvesting, the greater the chances of extinction appear to be.

• The risk of extinction associated with open-access is sometimes referred to as the tragedy of commons (Hardin, 1968). The term is some what unfortunate because extinction does not necessary follow (Eoa is an equilibrium at which a sustainable yield is taken) and use of common property is usually governed by rules and regulations. That is, under common property, a particular community owns the resource and manages it in between the private and open access regimes.

CONCLUSION

Based on the reasoning advanced so far we can conclude that:

• An open-access regime, in which no property rights are defined for named individuals or communities, risks extinction of the resource.

• Private ownership should maximize profits, which, in turn, should lead to restriction on rates of exploitation and conservation of the resource. However, in practice, various factors, such as the uncertainty surrounding the ownership rights, may lead to the overly rapid exploitation of resources.

• Common property regimes are likely to produce resource use rates somewhere between the private ownership and that of open access. Common property carries much lower risks of resource degradation, than open access, and the two should not be confused.

• Although intuitively attractive, maximum sustainable yield (MSY) is unlikely to be a rational management solution for renewable resources.

Recent policy decisions regarding over harvesting in Community Forests

Analyzing the harvesting in CF what we see that the harvesting costs are quite low often tending to be negligible because of the employment of unskilled labour in the activity.

Nepal Government in order to curb tendency of over-harvest (though based on MSY) decided (on 2067/3/31) to regularize tree cutting in community forests with measures like minimum royalty price, 40% of the royalty amount in FDF (Forestry Development Fund etc). The decision was intended to control indiscriminate felling however faced stiff resistance from FECOFUN.

If we use Figure 1.1 to explain the effect of government decisions, we will see that the decisions of increasing stumpage price will further increase the price of timber in Kathmandu hence will not produce any desired effect, while the effect of depositing 40% of royalty amount in FDF – remains unknown.

Had the government propose measures like:

1. Employment of skilled manpower in tree-cutting

2. Provision of safety gears (helmets, gloves, vests, boots), improved tools (chain-saw) and insurance premium utilizing present legislation

There would have been a shifting of TC curve in Figure 1.1 with reduced harvest that may remain well within MSY.

Figure-1.2: Scenario of harvesting under increased Total Costs

TCL =W*T

Hmax

Costs

HarvestHL

HH

TCH = W1 * T