18 maximization of welfare unless the trade costs and the quasi-rents due to binding
trade quotas are minimized Barret, 2005. The spatial equilibrium condition SEC will occur when P
A
= P
B
+ T
BA
, where P
A
is importing price from B to A, P
B
is exporting price to A, and T
BA
is transaction trade cost from B to A. Except this equilibrium conditions, there two
possible situations, i.e. 1
If P
A
P
B
+ T
BA
, there will be more trade from B to A until restoring the SEC. This is when arbitrage occurs.
2 If P
A
P
B
+ T
BA,
there will be no trade until P
A
gets too small or P
B
so big, that P
B
P
A
+ T
BA
, than trade will occur from A to B. It is necessary to notice that T
BA
≠ T
AB
due to geography aspect namely “backhauls” phenomenon.
2.6 Deforestation: Supply and Demand Theory for Forest Product
The existing literatures assumed that deforestation is driven by the dynamics of supply and demand of forest products, particularly with regard to the
wood products. Based on this assumption, the theory of supply and demand is applied to understand the implication of wood price changes on deforestation.
Adapted from Hyde and Seve 1993, it considers Dt as aggregate demands for wood at a given time t, while the supply MCt consists of two components :
MC
i
as the supply of indigenous tree which is subsided over time, and MC
e
as the supply of plantings. The private marginal cost of indigenous harvests refers to the
cost of collecting wood plus the other related transaction costs such as fee paid to government i.e. forestry department.
When the growing stock of indigenous trees is decreasing, the remaining stock becomes more remote, which will generate higher harvesting costs, and thus
the supply of indigenous tree will shift to the left over time MC
i
t + n. While MC
e
is considered as constant over time assuming that there is no cost-reducing technical change in tree growth. From this point, sustainable supply occurs when
the growing costs is equal to the harvesting costs. Assuming that population and economy are growing as time passes, then the aggregate demand of forest
products will shift outward as a consequence, and the supply will shift in the
19 MC
i
t + n
MC
i
t
MC
t
t D t + n
D t Volume m
3
MC
e
Price
P t+n
P t opposite way as mentioned before. As we can see in the figure 6, MC
i
t will shift to the left MC
i
t+n, and Dt will shift outwards to Dt+n. An equilibrium condition will be achieved as the price increases from Pt to Pt+n.
When price increases e.g. due to the increasing aggregate demand of forest products, then the indigenous forest cover which is accessible will be gone. While
some forest areas which are less accessible and have higher harvesting costs will still exist but are not attractive to be harvested. Similarly, if harvesting costs is
increasing MC
i
shifts to the left then open access harvest opportunities will diminish as well as the indigenous supply. Given this situation, when wood price
is increasing, sustainable supply supply of wood which comes from managed land i.e. plantation will dominate. Indeed, the open access availability will
accelerate the reducing indigenous forest and cause more rapid conversion to sustainable supply as well as price responds to increase. If there are a plentiful
supply of wood and MC
i
increase slowly, deforestation may occur rapidly. The equilibrium price increases slowly as well without inducing a significant forest
sector adjustment. On the other hand, if MC
i
is steeper and shifts rapidly to the left, the equilibrium wood price will increase rapidly and the forestry sector is
responsive.
Figure 4 Supply and Demand of Forest Products Source: Hyde and Seve, 1993
20
4 METHODOLOGY
This chapter provides some information with the regard to methodological approach used in this study. First, it begins with the information about data
description: the type of data, sources of data, and so forth. Second, it continues with the analysis: how to process the data, some statistical tests, hypothesis, and
so on. Referring to the research objectives, there are two main analyses in this study: 1 price transmission analysis and 2 econometric modeling of
deforestation, which emphasizes on the implication of wood price changes on deforestation in Indonesia.
4.1 Data Description
