A game-theoretic model of timber prices with capital stock: an empirical application to the Finnish pulp and paper industry

The paper provides a framework to approach price and quantity determination in the roundwood market from a new perspective. In the spirit of the trade union literature, a model of timber price determination is formulated acco rding to which the forest owners' association determines timber prices and then forest firms unilaterally decide on the timber to be used. The novelty here is to incorporate investment decisions of firms as a strategic factor into the model. The structure of the model is the following. The game is p layed in two stages. First, the forest owners' association and the firms in the forest industry decide on timber price and capital stock, respectively . In the second stage, the firms determine timber demand conditional on the timber price - capital stock game, so that the equilibrium concept is the subgame perfect Nash equilibrium. This game-theoretic model is applied to t he annual data from the Finnish pulp and paper industry over the period 196 0-1992. Estimation and testing results concerning the price and quantity de termination of timber as well as capital stock, behavior are generally favo rable for the hypotheses presented. In particular, diagnostics and various test procedures indicate that these equations outperform conventional speci fications derived from the theory of the demand for factors of production.