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ECOS3997

Lab 4: Mining model with policy options

In this exercise, you will build on the simple dynamic model established in Lab 3 to investigate the  problem  of  non-renewable  resource  extraction  and  environmental  stock  pollution externalities.

Background: The government is seeking advice on a small mineral ore mining operation. The mine operator is Wongalee Inc. and the mine will be in the Hunter Valley region of NSW. The mine is mid-way through the approval process for operation. Using an on-line government provided calculator tool, the company has calculated an environmental bond value of $5m that is due to be posted in full at the beginning of operations. The local farming community is concerned about the poor environmental track record of Wongalee Inc and claim that there is ample  historical  evidence  that  the  mechanism  of  a  bond  is  inadequate  to  prevent environmental damage. Further, they argue that the bond is undervalued in terms of the real potential cost of the damage. This sentiment is echoed by local indigenous groups who argue that in cultural terms the undisturbed land where the proposed mine is to be located is in fact not possible to value. An alternative to bonds, a damaged land tax is also being discussed. This could be levied on a per hectare basis with the aim of creating an incentive for total clean up during mining operations.

The government needs both specific and general advice. In order to respond to claims about the bond amount, it needs to know how much environmental damage might be caused by the mining operation and its value.

The government also needs to respond about the policy mechanism - in particular, should a tax be used instead of the bond? The government wants to use the case study of this particular mine to put some figures on things and also wants an educated opinion from an economist on the general relative appropriateness of environmental bonds versus environmental taxes levied on damaged land.

Tasks : In this tutorial we will assess potential damages and explore outcomes from a per unit tax on damaged land to the proposed bond for Wongalee Inc. This will provide some numerical estimates that will facilitate the making of   recommendations to The NSW Department of Planning Industry and Environment.

Outcomes for the mining company (NPV of profit) and society (discounted SWF) will be compared under no regulation, a bond and a proposed damaged land tax (DLT) at a variety of rates. Wongalee Inc. claims the bond mechanism is adequate to ensure environmental protection, and local groups are calling for damaged land tax.

The spreadsheet model used for this tutorial is available on Canvas: MinePolicyModel.XLS. The results you generate from this lab should be used for your Written Report assignment. Open the file. There are 4 worksheets set up for the tutorial and the assignment. In the “No regulation” worksheet will be the results for mining outcomes in the absence of regulation.  The other worksheets “SWF” and “DLT” are for outcomes that maximise discounted social  welfare and discounted firm profit at for a damaged land tax. Recall the model presented in the lecture for Week 6:

Maximise a social welfare function:

 = =0  [   (  ,  ) − ( ) − ()]-   (())

subject to:   +1  =   −            for t = 0,1,…T- 1

+1  =  + ℎ            for t = 0,1,…T- 1

Qt   ≥ 0     and    Et  ≥ 0   for all t

 0  = a,      initial resource endowment

0  = b,      initial damaged land endowment

Control variables: Rate of extraction (tonnes of ore) during t: Qt. and rehabilitation of damaged land (hectares) during t:  Et

10 year finite time period t = 0,1,2… ..T

Assume firm is a price taker p =$34 ($/t)

5% discount rate; h=0.0005; d=4,000; c=6,000

Extraction cost function: (  ,  ) = 1,435.953 + 0.5(0.0000001 + 5.4611 ) Social damage function: d

Rehabilitation cost function: c 

Tasks to be undertaken:

1)  Open the spreadsheet MinePolicyModel.XLS. Familiarise yourself with the parameters in the workbook labelled  No regulation” .


2)  Enter the formulae to calculate mineral ore stocks (Xt) damaged land (Yt), total revenue, total  costs,  discounted  firm  profit,  society’s  costs  of  damaged  land,  per  period  tax payments, and discounted social welfare.

3)  On the no regulation” tab, call the Solver in Excel and optimise the net present value for the firm without the tax. Report the solution.

4)  On the “maxSWF” tab call the Solver again and optimise discounted social welfare. Report the solution.

5)  On the DLT” tab call the Solver and optimise the net present value for the firm with the tax. To find a recommended tax, repeat over the different values of taxes in cell L12. Report the solutions.

6)  Save the results in each spreadsheet to use as  information in your report the  NSW Department of Planning Industry and Environment.