Economics of Tourism and Recreation



Economics of Tourism and Recreation

Assignment 4

Due May 2, 2010

Taxes

1. Suppose the government imposes a tax on the hotel industry.

a. Graphically demonstrate the effect of this tax.

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b. Show in the graph the tax revenue to the government and the part of tax revenue paid by consumers and the part paid by producers.

[pic]

c. Show in the graph the deadweight loss due to the tax.

[pic]

2. With new graphs, demonstrate that if demand is inelastic the deadweight loss will be lower and the part of the tax paid by consumers will be greater.

The demand curve below is steeper, signifying demand is inelastic.

[pic]

1. As one can see the deadweight loss is lower. This is because production falls less when demand is inelastic.

2. Also, one can see the portion of tax paid by consumers is greater. This because the fall in supply translates primarily into a large price increase when demand is inelastic.

3. The tax revenue is greater. This is because production is higher when demand is inelastic, hence there are more units to tax.

Hence we can observe that is better to tax when demand is inelastic in the sense that deadweight loss is lower and revenue is higher. Moreover, when demand is inelastic this means that consumers, or tourists, are paying most of the tax.

4. Do you think demand for tourism is elastic or inelastic?

If we mean demand for Oman tourism, then it is elastic since there are many other countries a tourist can visit.

The Possibility of Negative Value Projects

Suppose private investors want to develop a beach resort and the value of the beach resort is 600000 per year and the construction cost is 50000 per year. Currently the beach is used by 100000 local residents for recreation. Furthermore suppose that each local resident values the beach at RO10 per year.

1. What is the opportunity cost of using the beach for a resort?

Opportunity Cost = 100000*RO10 = RO1000000

2. What is the optimal use of the beach?

Since the beach resort brings in a net value of 600000-50000 = 550000 per year, and the local residents value the beach at 1000000 per year, the optimal use of the beach is to use it for local residents, left undeveloped.

3. If the government grants the right to build the beach resort, what will be the total economic value of the resort (including the opportunity cost)?

Total Value = 600000-50000-1000000 = -450000

4. Why might the government allow the development of a negative value project? (HINT: It might help to think in terms of who is benefiting from the development and who is losing)

Perhaps because the benefits to building a resort are so easy to identify and determine who it is that benefits, whereas the benefit to local residents of leaving it undeveloped are difficult to identify and determine who it is that benefits.

Externalities

1. What is an externality?

A negative externality is when a third party is harmed, or bears a cost, because of a trade between two other people.

A positive externality is when a third party is benefited because of a trade between two other people.

2. Give some examples of a negative externality in tourism. Give some examples of a positive externality in tourism.

Some negative externalities of tourism might be …

i) traffic congestion if tourists all come to a specific area

ii) extra demand on resources, such as water

iii) overbuilding in a particular region

iv) pollution or littering by tourists

v) negative cultural interaction between tourists and local residents

Some positive externalities in tourism might be …

i) Improvement in recreation facilities

ii) Improvement in infrastructure of airports, roads, etc.

iii) Preservation of Heritage and Culture

iv) Cultural exchange between tourists and local residents

3. What problem is created by a negative externality? What problem is created by a positive externality?

The problem of a negative externality is that neither the producers or consumers have to pay for this extra cost of producing the good. That is, if somehow producers could be forced to pay this cost then their private cost would reflect the true social cost and it would get factored into the decision on how much to produce. But since it is a cost they do not have to pay, it does not get factored in and overproduction occurs. That is, production is beyond the optimal amount from society’s perspective.

The problem with a positive externality is that the extra social benefit of the good is not reflected in the willingness of consumers to pay for the good. Thus suppliers are not responding to what is best for society, but only what is best for consumers. So production will be lower than what is optimal for society.

4. Suppose an area becomes heavily touristed.. The number of tourists create a traffic congestion problem. This creates a negative externality for the local residents. Furthermore suppose the tourists value that destination at 500, while the local residents value no congestion at 700.

a. What is optimal; should this area be used for tourism or not?

The area should not be used for tourism.

b. Suppose the tourism operators initially have the rights to bring tourists to this area. Show that private bargaining with the local residents will result in the optimal outcome.

The locals would pay up to 700 to the tour operators to not bring tourists. The tour operators will accept any price greater than 500 to not bring tourists. Hence any price between 500 and 700 will result in the optimal outcome of no tourists.

c. Suppose that the local residents initially have the rights to exclude the tourists from the area. Show that private bargaining with the tour operators will result in the optimal outcome.

Local residents would accept any price greater than 700 to allow tourists. The tour operators would only pay a maximum of 500 to be allowed to bring tourists. Hence no price exists such that tour operators will be allowed to bring tourists, and thus we have the optimal outcome of no tourists.

d. Now suppose again that the tourism operators initially have the rights to bring tourists to this area. Furthermore suppose that there is a transaction costs paid by local residents equal to 300 whenever they bargain. Show that private bargaining between the tour operators and the local residents will not result in the optimal outcome.

In this case the most the locals will pay to bring no tourists is 700 – 300 = 400. However, it will take an amount greater than 500 for tour operators to not bring tourists. Thus, we do not get the optimal outcome since the transaction costs are too high.

e. Under what conditions do you expect the transaction costs to bargaining to be so high that private bargaining will not solve the externality?

Transaction costs will be high when there are a large number of people involved, when the transaction is complex, and when contract enforcement costs are high.

5. If private bargaining cannot solve the externality, what two types of government policy may be able to solve the externality? Which type of government policy is a better method of solving the externality? Explain.

In such situations, the government can respond.

1. Regulation.

2. Taxes and Subsidies

Regulation forces individuals to the “correct” behavior.

Taxes/Subsidies are used to provide the incentive to do the “correct behavior”.

When possible, taxes/subsidies are better. The reason is they have the effect of “internalizing” the externality. In other words, for a negative externality the tax placed on the activity is essentially forcing the person causing the externality to pay the social cost created by the activity. And for a positive externality, the subsidy given for the activity is essentially providing some compensation to the person for creating the social benefit associated with the activity.

Common Resources and Sustainability

1. What is a common resource? What problem is created by a common resource?

A common resource is a resource that is non-excludable. That is, no one can be prevented from using the resource.

One person using the resource reduces the amount of resource for others. But because the resource is non-excludable people will continue using it until there is no more left. That is, it is used to point of exhaustion. This is known as the “tragedy of the commons” and generally is true for any exhaustible resource. We state it generally as follows:

Tragedy of the Commons: A common resource will be overused to the point of depletion. That is, the resource is not conserved.

2. If tourism is based on common resources (e.g. natural resources such as mountains, beaches, etc.), then explain how this affects the sustainability of tourism.

What this implies is that if we are relying on a common resource as a source of income, it will not be a sustainable source of income. That is, the resource will be depleted and income derived from it will not be sustained into the future. Hence whether or not tourism resources are common resources is a very important question in determining if tourism income is sustainable.

3. What are the solutions to common resource problems?

One could solve the common resource problem by making it a private resource. Since it is privately owned, the owners receive the benefit from conserving it.

Even if it cannot be made private, it may be possible for those people directly affected to find a solution. For instance, they might control access to it and ensure the resource is conserved. (the example of fisherman establishing a quota for fish caught is an example). However this requires the cost of coordinating the activities of the affected people be relatively small.

If it cannot be made a private resource, and the cost of coordination is high, then government control of access to it (with potential fines for overuse) may be the only solution left.

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