Shadow price and Shadow wage rate

1
Shadow price and Shadow wage rate

• Concept
• Distortions in prices
• Two approaches of shadow pricing
• Examples of shadow pricing
• Shadow wage rate

2

• In a purely competitive market, market price can
  be used in economic analysis because in such
  markets, the market price reflects the real
  scarcity of the goods/services to the society.
• The price at which a producer purchases a
  producers good/service/resource production
  factors such as labour, capital and non-factor
  inputs (seedlings, fertilisers) is ultimately
  based on the price of the consumers good he
  produces.
• In a competitive market the price of a producers
  good reflects the marginal productivity of the
  production factor used and their opportunity cost
  (the opportunity cost of a production factor is
  the net value of a production in the situation
  without the project that is foregone when the
  factor is used in the project).
• Hence, in a competitive market the market prices
  of the production factor can be used.

3

• However, the market is not always perfectly
  competitive due to the following reasons
• - Distortions in the market due to government
  policy (import quota, tariffs, subsidies,
  rationing, price control)
• - The existence of involuntary unemployment
  because of high minimum wage rate
• - Monopolies and monopsonies
• External effects, which exist wherever an
  economic activity in the form of production or
  consumption affects the production or utility
  levels of other products or consumers, and the
  effect is unpriced or uncompensated (Dasgupta and
  Pearce, 1978).

4

• Under the above mentioned situations, the market
  price do not reflect the real scarcity to the
  society.
• In Economic analysis, the distortion in the price
  is removed by calculating new prices that do
  reflect the real scarcity to society.
• These prices are called accounting, efficiency or
  shadow prices and in developing countries the
  difference between the efficiency price and
  shadow price can be considerable because the
  markets are less competitive than markets in
  industrialized countries.

5
Two approaches in removing price distortions

• UNIDO approach (1972) developed by Dasgupta, Sen
  and Marglin tries to correct domestic prices if
  distortions exist
• OECD approach (Little and Mirrlees, 1974) takes
  international prices as a base for accounting
  prices border price of traded goods reflect
  real opportunities open to the economy. This
  approach is used widely by international
  organisations.

6

• The ratio of efficiency price and the market
  price is called the Conversion factor and the
  Central Planning Office has often available the
  conversion factor of a large number of goods and
  services.
• The conversion factor also include the extent to
  which the currency is often overvalued and an
  accounting exchange rate has to be used.
• A large number of forest products can be in
  principle exchange on the market but they are
  actually not sold on a market. The goods are
  usually consumed by the producers or collectors
  household (e.g., NTFP). If there is a competitive
  market in the village where these products are
  traded then we can take this market price, but
  marketing costs have to be deducted.
• If no market prices are available, then the value
  of these products are to be derived from products
  otherwise people had used, so called substitute
  products. An example of pricing fuelwood from
  substitute product kerosene is given as an
  example.

7
Estimating firewood value using kerosene as
substitute

• Project output Fuelwood
• Substitute product Kerosene with CIF price
  0.40/litre
• Caloric value Kerosene 3200 kcal/lit
• air-dry wood 188000 kcal/m3
• Imputed substitution
• For wood
• /m3 0.40 / 3200 kcal
• 188,000
• /m3 (188000 0.40 ) / 3200 23.50
• Source Gregersen and Contreras, 1979.

8
Derivation of shadow price for project fuelwood
substituting crop residues (Hypothetical example)

• Basic information
• - Crop residue removed per ha/yr 2 tons
• - Corn crop value increase per ha/yr
• if residues left on fields 20
• - Heating value of 2 tons crop residue 376000
  kcal
• - Heating value of 1 m3 of project
  fuelwood 188,000 kcal

9
Calculation of fuelwood shadow price

• Heating value of 1 m3 of project fuelwood
  heating value of 1 ton of crop residue
• Corn crop value increase due to 1 ton of
• crop residue 20/2 10
• Value of 1 m3 of fuelwood 10
• Source Gregersen and Contreras, 1979.

10
Shadow wage rate

• Social wage rate is concerned with the monetary
  transfer resulting from employment. The question
  is - who is advantaged, who is disadvantaged, and
  by how much?
• If decision to accept forestry work was rational,
  then
• forestry wage - extra disbenefit gt
  former wage
• Therefore,
• forestry wage - former wage gt extra
  disbenefit (gt 0)
• (Disbenefit leisure time given up
  dissatisfaction caused by work)
• Those affected may include
• The worker
• Those who take on some of the workers prior
  employment
• The workers former employer (if any)
• The workers new employer
• The government, even if not involved as an
  employer

11

• In estimating shadow wage rate with extra person
  employed in a project, it is necessary to
  consider three different types of costs, namely
  foregone marginal product, changes in consumption
  and savings, and changes in leisure.
• According to marginal productivity theory, labour
  will be hired up to the at which the marginal
  value product equals the wage.

12

• Transfer of labour from rural to urban setting is
  associated with changes in saving and
  consumption. Increase in consumption may accrue
  to more than one labour.
• Changes in leisure will have impact on disbenefit
  factor of employment.