,
Economics of Natura/ R
~o
Economics of Natural Resources'
Rabindra N. Bhattach
arya
INTRODUCTION
It has been mentioned in Chapter l that the environment, in the form
of natural resources, provides energy and materials that are used to
produce goods and services to satisfy human needs. Traditional usage
confines the term natural resources to naturally occuring resources and
environmental and ·ecological systems that are useful to mankind or
could be useful under feasible technological, economic, and social
circumstances. Examples of natural resources are forest land and its
multiple products and services (e.g. timber, wild-life habitat etc.),
natural land areas preserved for aesthetic, recreational, or scientific
purposes (e.g. silent valley ofKerala, wet lands of easte~ Kolkata.etc.);
the fresh and salt water fisheries; mineral resources that mclude mmeral
fuel~ and non-fuels (e.g. coal, aluminium etc.); nomnineral energy
sources of solar, tidal, wind, and geothermal systems; water resour~es;
and also the waste-assimilative capacity of the environment and ecological
systems. These examples make it clear that wh~t we perceive as natural
resources depend on the conditions we have mhented from the past,
current or foreseen technologies, economic conditions, and tastes. For
instance, a century ago, not much was known about benefits of wetlands,
and uranium was not known.
This chapter deals with the economics of natural resource u~e. 1n
particular•we analyse how society should exploit a resource efficiently
'Some sections in this chapter draw liberally from the relevant chapters of
Fisher ( 198 I), Pearce and Turner ( 1990) and Titenberg (1998).
esources 47
d the rate at which a rational firm sh Id .
an h time . To begin with we ad ou exploit such resources
throug that is used to dist in ~~ta reso.urce taxono~y (classification
system) . b"l't g sh various categories/measures of
reso Urce ava1 1a 11y.
f
We then turn to the question of how to all t
oca e one such category
resources (namely exhaustible/depletable reso ) .
o . . . . urces over time
succeeding d1scuss1ons will use these principles for developing models
of renewable resources.
A RESOURCE TAXONOMY
Three separate concepts are normally used to classify the stock of
exhaustible/depletable resource . They are ( t) current resources.
(Z) potential reso~rces,. and (3) resource endowment. These concepts
and their interrelat10nsh1ps can be grasped with the aid of the 'Mckelvey
diagram' used by the U.S. Geological Survey and the U.S. Bureau of
Mines (Figure 2.1).
The diagram has two dimensions-one economic and the other
geological. As we move from top to bottom we move from cheaply
extractable resources to those extracted at higher costs. A movement
from left to right represents increasing geological uncertainty about the
size of the available resource.
Current reserves (white area in Figure 2.1) are defined as known
resources that can profitably be extracted at current prices. The ir
magnitude can be expressed as a number. The amount of potential
reserves, on the other hand, depends upon the price people are willing
to pay for those resources-the higher the price, the larger the amount
of reserves potentially available. For example, techniques, more expensive
than conventional ones, generally allow greater amount of a resource
to be recovered. As the price per unit increases, the amount of a resource
that can be economically recovered also increases. Thus, potential
reserves can be defined as a function rather than a number.
The natural occurrence of resources in the earth's crust .rep~e_sents
resource endowment. It represents the upper limit on the ava1lab1hty of
. resources. Smee. . of the resource endowment does
terrestnal the size
not, in any way, depend on the price, it is a geological rather than an
economic concept. . rt t Failing to
These distinctions among the three concepts are 1~P 0 an · d
take note of them may lead to erroneous conclusions · We nee to
48 Rabindra N. Bhattachary a

Total Resources
Identifi ed -
r
0 ten
P d Ov-<
Economics

..-..ber that d ata on current reserv

erne•..
0r

t 1· al reserves . So also we need to

,.,ment cannot be made
'1

avai
N
at ura/ R

lable
esources

es do n I
rememb h
o represent the m .
49

ax1mu m
,
Undiscovered
11 . • as potent"er 1t at the entire resource
Demonstrated I Inferred e
eoP
le will b e w1llmg to pay. Certain
. . mineral res
ia reserves at som
e price
Measured Indicated I P
cost ly
to extract. It 1s not
.
likely that an .
Y society c
ources are prohibit' 1
1ve y
Wl
·llincr to p ay the price necessary to . urrent or future would
Reserves Hypothetical Speculative be c, . . extract the Th ' .
. ly that the max unum feasibl e size of the 11_1 · 1s. then , would
imPbe smaller than the resource endo'""""' potential reserves is likely
to .... ,ent. Box 2 1
.E "§"'C:
u
..-..e ideas about the state of two reso · and Box 2.2 oive
0
us s 0 ,.. . . urces (on h . .,
C: "' renewable) m India. e ex austible and the
0 E oth er
w
u e
"'
0..
u Box 2 . I : Explorat ion and Production f
.E «l
C o Petroleum in India
0
C: "§ d ia continues to be one of the least explored
In
sins only 6 h ave so ",ar been explored aceregions . · Of the '6
- sed'1mentary
0
u "'E
0
.D .D ba , , . , ount111g fo r only 30
:::, :::, the country s prognosticated reserves. Ind ia' b per cent
er., er., of . . . 5 aIance recov bl
-1 reserves are declining co ntmuously after peak· era e crude
o1 d f rng at 806 mt in \992 Th.
indicates the nee or greater exploration dforts. 1s
Figure 2. I Resource Taxonomy.
Source : Parikh, K .S. (ed.) ( 1999). India Development R
. . p eport 1999-2000.
Oxford Umvers1ty ress . ·
Notes:
Identified resources: Specific bodies of mineral-bearing material whose location Natural resources, as
quality, and quantity are known from geological evidence, supported b; . we have said before ' include renewabl e resources
engineering measurements. such as fish popul~t1on and fo rests and non-renewable ex.haustible
resources such as 011 reserves and mineral de posits. Thus for another
Measured resources: Material for which quantity and quality estimates are
within a margin of error of less than 20 per cent, from geologically well-known useful classification of natural resources, we adopt the convention that
sample sites. classifies natural resour~es as r~n~wable and exhaustible depending on
Indicated resources: Material for which quantity and quality have been estimated, their rates of regeneration. Oil 1s exhaustible because its formation
partly from sample analyses and partly from reasonable geological projections. requires millions of years . It is not an economically meaningful time
Inferred resources: Material in unexplored extensions of demonstrated resources frame . Trees and fishes are renewabl e because they can grow to maturity
based on geological projections. within a reasonably short span of time. Thus it is possible, though not
Undiscovered resources: Unspecified bodies of mineral-bearing material inevitable, that a flow of these resources could be maintained over time .
sunnized to exist, on the basis of broad geological knowledge and theory. It needs to be remembered, however, that for some renewable resources ,
Hypothetical resources: Undiscovered materials reasonably expected to exist the continuation and volume of their flow depend crucially on humans.
in a known min ing district under geological conditions. Overharvesting reduces the stock of fi sh, which in turns reduces the rate
Speculative resources: Undiscovered materials that may occur either in known of natural regeneration of the fi sh po pulation. This may even lead to
types of deposits in favourable geological settings where no discoveries have extinction of the otherwise renewable resource . For other renewable
been made, or in yet unknown types of deposits that remain to be recognized. resources , such as solar energy, the amo unt consumed by one generation
Source: U.S. Bureau of Mines and the U .S. Geo logical Survey, ' Principle of does not reduce the a mount avai labl e to the generations that follow.
the Mineral Resource Classification System of th e U.S. Bureau of Mines and Mana 0 ino natural resources of either kind has its own challenge .
the U.S. Geological Survey ' , Geolog ica l Survey Bulletin 1450- A, 19 76 . The challe n~e for exha ustibl e resources involves allocating dwi nd ling
 Rabindra N. Bhattacharya
52 Economics 0 r N
'1 at11ra/ R
eso11rces
•ce (p) in that period. lf the me is less than p, the su .
equa Is pn . . d . PP 11er 53
. cu rrent profits by mcreasmg
raise . pro uctton . However' whe n the fican pr ice
.1 h tractor of an exhaustible resource, such behaviour rnight 11n
s t e ex . . bl requi
extraction of more stocks tha~ 1s ava11a e ~o th~ firrn . re
C ases like this, then, require some mod1ficat1ons of the
Since an exhaust\'bl e resource 1s . 111mte
· . dm . quantity and
standard
.
t eOry-
h . . . ts n
ro ducible extraction and sale of a unit today mvolves an opp 0t
p , . ortunity
cost: the value that might have been obtamed at some future dat .
opportunity cost is · usually given · t he name user cost (uc). The p e. 1 h1s
. . resence
of user cost is cen_tral to the econ~mics of exhau~tib\e resources. User me
cost does not exist for conventional reproducible goods since the
consumption of an amount now does not reduce the quantity that
be consumed in the futur~ ; additional quantit~es can always be producce:~
However, a barrel of 01I extracted today 1s a barrel unavailable t Quantity
extraction in the future . In dec1'd'mg whether to extract and sell an or Figure 2.2 Optimum Extraction of an E h .
' x aust1ble Resource.
additional barrel today, the extractor must consider not only the cost of
pumping the barrel, but also the cost of foregoing the highest return that fu ture prices. These price expectations determine th
additional curren t ex t . A competitive su e oppor1un11y
raction. . h cost
could have been earned if the oil had instead been pumped and sold in ofture pnces. to be suffi1c1ent
. Iy Iow compared with the pp1ier t at .expects
the future. Hence, it is necessary to have a more inclusive definition of fu . . l . h . current pnce may
marginal cost and we call it augmented marginal cost (Salant, 1995). xtract and sell mtens1ve y mt e current period J. udginoth .
e .. . • ::, eopponumty
The augmented marginal cost (amc) is, then, ·defined as the marginal Co st of add1t1onal
.
extraction to be small. But if future prices
. . areexpected
cost of extraction (me) plus the user cost (uc). to be sufficiently high, the same current pnce may induce no extraction
whatsoever, today.
When me is redefined in this way, it is optimal for a competitive
resource owner (firm) to extract the resource in each period to the point For some further r~sults let us, for simplicity, assume just two periods:
where its amc equals the market price (p) . Instead of the usual efficiency the resource owner either extracts and sells the resource today, in period
condition, price (p) = marginal extraction cost (me), we have:
o, or retains it in the ground until the next period I. Let the price he can
obtain for a unit of the resource today be Po and the price he expects to
p =me+ uc . prevail for a unit in the next period be Pl - The cost per unit of extracting
the resource and delivering it to the buyer is C, which is not expected to
This is the first condition of optimal depletion. As shown in Figure vary b(!tween periods O and 1, that is C = me remains constant.
2.2, it implies that less of the resource will be e~tracted _today than if it Because the owner has a fixed stock (to be supplied from) of the
were a producible ordinary good or a resource. Given the m".erse demand resource, any unit sold in period O will reduce the quantity that can be
function p = p(y), where p is the price and y is the quantity extracted, sold in period l . If he sells the unit in period O he \:ill rec~ive net
only y* units (rather than y** where p = me) will be extracted b~ a revenue of p0-C but forgo revenue of p1- C in t~e following penod. The
resource planner or a price-taking firm seeking to allocate extractl?n value in period O of the net revenue foregone 1s its present value (p,-
efficiently over time. This leaves a positive difference AB (the opportunity C)/( I + r) where r is his discount rate.2
cost/user cost) between p and me.
Beneath the apparent simplicity of this rule lies a wealth of subtl~ty 2
The present value of a stream of net b, neftb_. B, .... , Br received over a
(Salant l 995) . The rule implies, for example, that the current extraction
rate by' a private owner of a natural resource depends not only on th e l3 ) =
T
L BJ (l +r)
I

current price, as in the standard theory, but also on expectations about period of T years is computed as PY lB,........ , 1
,
0
54 Rabindra N. Bhattacharya
Economics of Natura/ Re.rnurces
Hence his return from selling a unit today will be : 55
) . g t 931) of exhaustible resource extract"
(Po - C) - (p1 - C)/(1 + r) u 0 tel in ' . ion . 1t says that along
to ..-. . um extract10n path, where the resource . .
opllm if . I owner is indifferent
( -C)/(l + r) is the opportunity cost of his decision to sell . the the options o extractmg or eaving the resource in g d h
to I
pI . d . . I . b a un it tod
It is the user cost of his ec1s1on . t anses ecause he is faced ,,;" ay_ os .r the resource, ne I oif m O rg ina •
extraction cos ts that . h
roun . t e

alternative of selling it in the fo_llowing period . If 1th the prt·ce OJ to rise at a rate equa1 to the discou nt •t A is. t e user .
t has - h. ra e. numerical
cos ay help to , 11 ustrate t 1s fundamental co d"t" S
(Po - C) > (p1 - C)/(1 + r) rnple rn . n 1 10n. uppose the
e,ca te is \ o per cent and th e net price (p _ me ) th t
. rest ra . . a 1s. user cost
1nte . of the resource is Rs . 20 . If the net price (us ) .
he will be better off selling his resources in the current period. If, on r unit O er cost 1s not
the other hand, pe ted to grow by I per cent to Rs. 22 next year. it pays to extract
e}{pec f the resource in the current period because the result" •
ore o . '. . mg income
(po-C) < (p1-C)/(l + r) f1l les will earn 10 per cent interest if invested in interest bear1·no
fi orn sa · · d "'
r sets. If the net pnce .is expecte to go above Rs. 22 that is , to grow
he will be better off by leaving it in the ground . His optimum am
.
of current extraction . given
1s . w h ere ount as than the rate of interest- the producer will have no incentive at
faster · t · d Th . ·
all to e xtract m the curren . peno . . is is because any un it extracted
Po-C = (p1-C)/(1 + r) day will (even after interest eammg) be worth less in a year than a
(2 . I)
This implies that Po = C + (Pi - C)/(1 + r) to. tracted and sold a year from now.
(2 .la) unit ex . . .
Equation (2.la) states our earlier result that the current price of the If m c of extraction 1s small relative . to the price of the resource .
resource when it is extracted optimally, should be equal to the me plus equat 1·ons (2 .2) or (2 .2a) approximate to
PI /p o = l + r or Pl = Po ( l + r).
the user cost (uc) .
With reproducible resources there is no element of user cost since
Thus along the optimum path resource prices grow at the discount rate.
resources are produced in each period to satisfy the demand in that
The higher the discount rate the faster wi II the price of the resource rise
period and there is no carry over from period to period. Hence, as we
have seen earlier, for a reproducible resource the optimum output is along the optimum path . A h~gher discount rate reduces the user cost
of the resource and causes mme owners to deplete their resource at a
given where Po = C .
faster rate . In reality, of course, extraction costs are never zero . Whenever
Transposing equation (2.1) we have
they are positive, a price increase equal to the interest rate v,ould cause
(p 1 - C)/(p 0 - C) = 1 + r (2 .2) the net price to rise by more than the interest rate . For example, suppose
which implies that (p1 - C) = (Po - C) (1 + r) (2 .2a) the price per unit of a resource is Rs . 30 and the net price is Rs. 25 .
This equation (2 .2 or 2.2a) is the second condition of optimal d~p_letion A l O per cent price rise (in the rate of interest) would boost the net price
and is usually described as the fundamental equation (due, ongmally, from Rs. 25 to Rs . 28 , or by more than 10 per cent. This difference would
give every extractor an incentive to postpone extraction rather t~an
satisfy current demand. If such imbalances are to be avoided, the pnce
where r is the appropriate interest rate, B is the amount of ~et bene~~:
0
in successive years must rise by less than the interest rate. .
receivers immediately, and B is the amount of net ben~fits received t ye_n
1 We will see that this analysis may illuminate man~ queS t10_ns or
from now. The process of calculating the present value 1s called dis_count '. gd practical policy. Let us consider for illustration. the following q~es~io~s.
and the rate r is referred to as the discount rate . One rupee receiv~ · d 111 peno
.. .
Suppose a state-owned or controlled enterprise say Coal India L~mite_d
tis equivalent to l/( I + r)' - 1 rupees in period I, or that one rupee m the 1111 t1~1
period is equivalent to ( I + r)' - 1 rupees in period t. At a discount rat~ of 1 (ClL) is entrusted with selling an exhaustible natural resource (m th ,s
per cent a firm will be equally well off 1f . 1t
. earns R s. I 00 today (which
. can
3
generate, Rs . 10 of interest mcome)
. or .if 1t
. earns Rs. 110 on e year trom now. These questions are primarily bast:d on Salant t 1995).
 Rabindra N. Bharrachmy a Economics of Naturu/ R
esources
56 57
coal) 011 the world market. For a small country4 c . third problem where (say) it is propo d
examp le . . an II be . !fl the /and polluting gold mine but the n se to shut down a highly
it to the pomt where the me of extraction equ I tight d or .. h d' line operat
10 ex tract . . a s the vallle riod to m1t1gate t e 1slocations cau db or 1s permitted
el price? Is ,t ever prudent to refram from extractin World ce pe I · ' se Ythe cl
mark . . g a reso 11 gra period premature c osmg lowers th osure. during
ugh it is profitable to begm with that is current p . Utce race . e uc of an add' • ~
eve11 tho ~ . ' nee e ' the g ntly the amc m eac 11 period before th d lt1onal unit.
the me of extracting the first u111t? Xceeds 5eqt1e ' 1· e ate of clo ·
con . as before the po rcy was announced If th sing is lower
Credit may be more tightly rationed (and interest rates h. h 1t W • e sequen f
. . ig er) in than . nchanoed, the mme operator will find 1't ce o world
country than 111 another. How does this affect the form one pric~ 15 ~hrough~ut the grace period. profitable to intensify
. er count '
relative rate of resource extraction? ry s rt1ifllflg
Suppose a government decides to restrict the extraction of
that 1.s privately
. owne d an d extracte
, d because the resource is a resour. ce RIJS A SUBSTITUTE (BACKSTOP)
. I d'
hiohly valuable (sue h as go Id 111 n 1a) or because the extract·
consider d
e
foWA .
o ion proc discussion so far considered optimal depletion of an .
oenerates pollution (such as gold mining which uses mercury _ess our e when we implicitly ruled out availability of ex~aust,ble
:, . . or arsenic) resourc . . t· II d any substitutes or
Is it right 111 such cases to give the extractor a grace period b t'. ·
, as 1t 1s some 1mes ca e , of the resource co d
. I . d
restrictions are effiect1ve Y impose to overcome the dislocat ·
e,ore the 'baC kstop · nceme . However
.. . ions that so happen that a substitute resource possibl ·
such pohc1es will cause? it ,naY . 1 . • Y a renewable
ce is availab e at a constant maro111al cost This .
resou r , . . ::> · scenario could
Each of the questions raised above ceases to be puzzlin the problem of optimal depletion of say for exampl .1
pose . A h e 01 or natural
attention.
1s. proper Iy re tiocusse d on the opportunity cost of g once with a solar substitute. not er example could be optim I d 1 .
. . current gas . d . a ep et,on
extraction and how that cost changes when a new policy is antici t d exhaustible groun -water with a surface water substitute Wh
. h I d . b pa e . 0f . Id I . I · . at
Exp~n dmg s ort-run ~oa _pro uct1?n ased on the equality of me of wo Uld be the optima ep et1on ru es 111 these circumstances"'
extractwn and market pnce 1s excessive because it fails to account for We note that the amc for the exhaustible resource cannot exceed th
the future net return (profit) foregone, when an additional ton of coal me of the substitute. .
The society could always opt for the use f e
d o a
is extracted. Moreover, if this opportunity cost is sufficiently high, no renewable resource mstea , whenever it appears cheaper to do so. Thus
amount of the resource should be extracted today even though the although the maximum willingness to pay (the 'choke price') sets th~
current price exceeds the current me of extracting the first unit. upper limit on amc and for that matter on p when no substitute is
As regards the second problem, when the real interest rate rises, the available 5, the amc of extraction of the substitute sets the upper limit
uc of extracting another ton declines because the future profit (from the when a substitute resource is available at amc that is lower than the
ton that must be foregone) is worth less today (that is discounted profit choke price. Some simple analytics at this stage may appear illuminating.
is low today). Hence, even if me does not shift, the augmented me (amc) Rewritten, equation (2.2a) provides the following equation for the
in early periods will fall. As a result, the same sequence of prices would two period time path of price when no substitute is considered:
generate an initial expansion in extraction. This outcome can be used Pl = me + (p0 - me) (I + r).
to explain differences in the behaviour of two countries selling the same
natural resource on the world market. Assume that both countries Extending this to any number of periods. we have
have approximately the same underground reserves and costs of Pt= me+ (p0 - me) (I + r)f (2.3)
extraction. If credit is rationed more tightly in one country, that country
should extract more rapidly in the short-term in order to maximize As time passes the price draws away from me, rising at a rate that
national wealth. approaches the rate of interest (r) as the uc component of price comes

lSuppose that demand in any .period is giwn by the equation P = 1 y. ?-

iA small country is one that sells on the world markets but that docs nol Clearly amc and p can not rise above Rs. IO per unit. because at th at pnce or
have a large enough market share to be able 10 influence world prices (a pricc- maximum willingness to pay quantity demand. foils to zero.
taker).
 Rabindra N. Bhaltachmy a Econ o m ics of Natura/ Re~o ttrces
58
59
minate the fixed marginal extraction cost compo . th a t th e initia l use r cost at t = 0 ( .
to do . nent . Th ·
hown in Figure 2 .3 . . is is t, iS ifllP(lhe s cost of the back stop and the c~stPo t· me ) ,s the difference
f en td aete o f tra ns 1t1o
. . o oil discou t d b
s Does price rise indefimtely when a substitute is available? bef'-"e n (T). Substitutin o this . n e ack
ha ve mentioned , _generally, we may suppose that a limit on th ~ ~s ,.,,e f1"1 the . (2 4) we o btai n ::- . ex pression fo r Po me
fro a t1on · ·
amc and price will be set by the cost of a substitute or b k rise of ·nto eqt1
oil the backstop could be coal (exhaustibl e ), and ultimatetc st0 P. For , ( rn cb - m e) .( I + r)'
of ~olar energy (renewable). The backstop (coal or solar e;e;ome form Pr ~ rn c+ ( l + r)T
a resource or a technology that can provide at a higher c gy) 1s Jllst . . pl ies a n expression for the price of 011 - t
. ) H . .
serv ices as 01I (energy . owever, ,t ts not s upposed to be xh
Ost the s
arne and thtS irnp (a nd th e cost o f 0 11)
·
at any time 1 < T
in erms of the cost
any meaningful time frame . e au sted in f backsto
o ( rnc o - me)
Let us suppose that a backstop exists and let it be solar
· • . energy Th · Pr ~rnc+ ( l + r)T- r (2 .5)
can provide energy at a margma 1 cost equivalent to me · 1s
barrel of oil. Clearly th is is also the price and amc =
. . I k
rup~es Per
c, since a
! . translated into Figure (2 .3 ), shows that user cost rises at the rate
unhm1ted so ar resource stoc cannot have any uc. It can be h n 'fhIS, me) and the aug mented margi nal cost and price nses t
s own th 1 r to _(rnCbT- the switch po int. o mcb
the cost of the backstop performs two functions : It sets an u . ~
. an d amc o f 01·1 an d a Iso d etermmes
· at tune ,
on the price the initial uc topper
b lnn,1
to the me of extraction. e added
Suppose that the transition ( called the switch) from oil t h E XPLO RATIO N A ND T ECHNOLOGI CAL P ROGRESS
backstop takes place at time ' T' . Then , from equation (2 .3), the ~r~c: . c,· ple e x traction costs may rise over ti me as lower-cost reserves
is given by In pnn ' . . -
are depleted and higher-cost reserves remain to be exploited. The search
Py = me+ (p 0 me) (I + r)T resources involves costs. As more easily accessible resources
-
(2.4) furM W .
xh austed we must move mto less accessible areas such as the
are e ' . . . '
But with unlimited solar (energy) resource without any uc, we also have bottom of the ocean or high ~lopes o_f th~ mountain._This suggests that
PT = mcb, so that after some manipulation, equation (2.4) becomes the marginal cost of exploration, which ,s the margmaJ cost of fi nding
an additional unit of the resourc ~, should be expected to rise over ttme,
( - me) = (mcb -me)
Po (l+r)T ·ust as marginal cost of extraction does .
J Rising augmented marginal cost of a resource induces society to
exploration activities . Some of this exp loration would be s~ccessful. If the
Price, User me of extraction of the newly found resources ,s sufficiently low, this
Cost could lower, or at least moderate, the increase in amc and pnce.
Technological progress, in the present co ntext would be manifested
MC of Backstop (mcb) as reductions in the cost of extrac tion . However, wi th a fin ite amount
of a particular exhaustible resource , th e fa ll in ~c would not la5t
p0 - - - - - - - - - - - - - - - - - - - - - - - - - me indefinitely, because ultimate ly it would have to n se. This penod of
transition could last quite a long time though.

0 RESOURCE E XTRACTION A ND E N VIRONMENTAL CosT

Time
. an environmental cost
Figure 2.3 Time Path of Price and Augmented Marginal Cost and its Extraction of a natural resource may impose
. h. ty riohts are not us ua 11 y
Relationship to Resource and Backstop Cost. on society. In situations like t 1s proper - 0
, 60

we II -defill
(t IllS p
I
Rabindra N. Bhattacha,ya

ed and hence this cost is not internalized by th

•
. henomenon will be treated more elaborately in b ctors
f . . .
e extra
SU Se
Economics nf Nat11ru/ Resources

tJPdated onsidered two versions of the scarcity hypothesis: a strono

61

and ex.tended to the _rest of the world by Barnett ( 1979 ). The

h ters). The aesthetic costs o stnp mrnrng, the occupatio 9Uen 1 3tlttiors cthat unit co~ts of extractive (exhaustible material ) industrie~
c ap . I . . d I . na 1 he I
I,a zar
ds associated with coa mmmg, an t 1e acids leached int a th version,rise through_time; a~d a weak versio~, th~t costs in extractive
. . o stre
fr o m mine operations are
.
all examples
d I . I .
of associated envir ams
onlllen s110 t1id.,es should nse relative. tof non-extractive
. industries. The latt er
The cost of extraction an sa e ( mc ud mg user cost) is b ta1 ifldu~tr recognises the impact o ~echnical progress in lowering costs
costs . . orne b ers10° . 0 in modern economies.
ti1e resource owner and taken account of ( rnternal ized) in the cal culati Y " ducuo d ti
of how much of the resource to extract. The environmental d 0n of pro ·ve industries were e med broadly by Barnett and Morse to
c tract! ·
however, is an external cost and is not borne by the owner and alllage, r;,){ not simply mmera s an d f.oss,·1 fuels but also agriculture and
I
. d .. . . as such include which utilize the exhaustible resources of the soil. The initial
it will not be part of the extraction ec1s1on. It 1s important to kn
ow how forestr)', for the period 1870-1957. Barnett's update extended the
the market allocati~n, based o~ only th_e fo_rmer cost would differ from stu~Y wt: 19 72 . T~e ~nding~ totally.rejected t~e strong version of
the optimal allocat1on (depletion), which 1s based on both.
peno? -all ex.tractive mdust~1es experienced contmuously fallingcosts.
The inclusion of environmental costs results in higher res
. ource 5carcit)' h pothesis also received no support except in forestry. Forestry,
prices, which tend to lower demand. All other things being equal it 1he weak y nse is not an extractive resource and falls in the cateoory
would allow the resource to last longer. On the other hand wh true se ' . . . o
inthe ble resources. For all true extractive mdustnes, costs over the
environmental side-effects are ignored by the resource extractino fir en of renewa declined relative to the costs in non-extractive industries.
the price of the exhaustible. resource wou Id be too low, demand tooO highm, Jong term tudies also examined the proposition, derived in the earlier
and the resource would be extracted too rapidly over time. ' ~hese ~ t because of the influence of user cost, prices of exhaustible
The presence of environmental costs, in this way, forms an important secuons, t ahould rise relative to those of reproducible resources. This
intersection between the fields of environmental economics and natural reso urces . . s •Is also rejected by the ev,'dence.
resource economics. Arguments developed above confirm that proposiuon four basic reasons for the failure of the scarcity hypothesis
There are
environmental and natural resource decisions are intimately and (Bowers, 1997).
inextricably linked (Titenberg, 1998). h• h r grade resources are exhausted, lower grade resources
1· As :g ed in greater abundance. Furthermore, the difference in
are 1oun
d diminishes as the known stock expands.
RESOURCE SCARCITY gra es rt·cular resource becomes scarce, price rises are offset by
2 As a pa I . . ..
. . h ·n demand to substitutes (backstop). That rs, scarcity is
swrtc es 1
In the preceding sections we were specially interested in the relationship offset by decline in demand. .
between market-determined use and socially efficient use of a resource. in prices stimulate exploration for new deposits and
3. Increases
This section concerns the evidence on actual rates of use. Are resources • d ce increased recycling. .
getting scarce? We will consider two economic measures of resource ~e:hnical prooress influences supply by reduci~g extraction cos'.s
scarcity, namely cost and price to confront the question raised. 4. db makin; possible the exploitation of prev1o_usly uneconomic
Nineteenth century economist David Ricardo views the increasing an ~ l d demand bv encouragmg efficiency in
deposits. lt a so re uces -
costs associated with depletion as a limit to growth. In principle,
resource use.
extraction costs may rise over time as lower-cost reserves are depleted
and higher-cost reserves remain to be exploited. Certainly resources
have been extensively depleted over the last century and more. How MANAGING RENEWABLE RESOURCES
have costs behaved? . es and renewable resources is not
The predictions of Ricardian scarcity were examined empirically for The line dividing exhaustible resourc . in a sense, can be
xhaustible resources,
the USA in a famous study by Barnett and Morse (1963) and subsequently always clearly drawn. Just as e
 Rabindra N Bha1tacl1mya
62 Economics of Natura/ R
esources
xploration and technology, renewable r 63
d throue. I1 e· esour ..., ,5 carrying capacity for that spec, (
renewe d ~111 fact much of the current concern ab Ces ca ste,.. . · e, 1n the b
·I1auste . • • out r n ccosY ·on) The cumulative curve thu<; t k a sence of human
be ex . n involves renewable resources (F_1sher, 198 I). I-{ csource entl · . ' · a es the .
st1O 1·11 terV 'th at first success ively larger inc general lnRwic
exhau rces are different from exhaustible resource b O\vcver w1 rements th
wable resou s eca . 511aPe nes Note that the curve, as we have d · · en successively
reneh t t·lie)' are naturally regenerated on a time fra Use of 11er o · . rawn be i
h fact t a . . . me th sf11a . . al rnin1rnum level of population If th . , g ns at Xmin-
t e nan exploitation . Catchmg a fish or cutting a t at is cfltlC . . . · e size goe b 1 .
revant to I1ur . ree d 111e species 1s driven to extinction (X ) s e ow this
re h population of fish or tree rn any period. But u Oes I the o.
reduce t e d I . nIess th 1eve . useful for our purposes to look at the inform f .
. has already been reduce tot 1e pomt of the critical th e It is 4 in a somewhat different way. Figure ahion contained in
population . . resh O
O owth will replemsh the loss of biomass due to th h d, 1 · ure 2source
· stock on the vertical . axis and the 2·5 s ows the gr h
natura I :,r . h • . e arv fig 1eve 1of stock (X)owt
. . latively short penod. So, a1t oug11 1t 1s true that a r est . the re . .
within a re . enewabJ 1fl . ontal axis . The solid curve relates this orowth f ' on
be exhausted 1t need not be. e hortZ . .:, o the spe ·
resource Can ' . the d as the net annual increment to the po . cies.
lfankind shares the planet earth with many other living s . asure . h pu 1at1on or weights
• II I b Pecies f11C f (births mmus deat ), to the stock level. Left t .
i, .
11ereo d . . o nature and m
\VI1en bl.olooical
::,
species become commercra y va ua le they are sub· ·
. . ~ected t bsence of human pre at1on , Xe is the population level th t II
10 two opposing huma~ obJectrves. On the one hand, the value of the the a. X is known as na1ura1 equ1.1,.6num .
because at X
a w1
k. .
ecies to humans provides a reason for human concern about its fu btain - c . . c stoc 1s Just
sp . 11 y exp IO1ta
. bIe b.10log1cal· resource ture · o . g itself Reductions m the stock because of morta1 ·11y d
On the other hand. commerc1a placm . . or pre ator
. . .f s can re . 5 or (in the case of fish) out-m1grat1on would be exactly off t b .
also be pushed to the brink of extmct1O11 1 not managed sensibl specie b f b' se y
' y . se in the stock ecause o irths, growth of the resource (weight)
In the case of biol?gic~I ~esources .the ~1ze of the resource stock increa k d . . .
. h remaining stoc , an 111-m1grat1on (of fish).
(population) is determm~d JOmtly by b1ol~g1cal_factors and by actions in t e ·1·b . Id .
This natural equ1 .1 nu~ wou persist because it is stable. A stable
taken by society. The size of the populat1on, m turn, determines the
eqUI'librium is one m. which, movements away . from this equilibrium
availability of resources for future . As the flow of these resources over
sto k level set forces m motion to restore 1t. If, for example, the stock
time is not purely a natural phenomenon, a crucial issue is the optimum c orarily reduces below Xe then it will recover because for all stock
temp h. . . Th .f
(efficient) rate ofresource use over time and over generations. A related levels below Xe growt 1s pos1t1ve. us I the stock is reduced to x,.
question is: can the market be relied upon to achieve and sustain this
rate? Using the fisheries as an example of a renewable resource we will
address these issues here. Resource
Stock (X)
x,
BIOLOGICAL DIMENSION: GROWTH C URVES

Like exhaustible resources, renewable resources cannot be reproduced.

Thus, even though available stocks are affected by human intervention
via their levels of exploitation, the economics of renewable resources
depends, crucially, on assumptions about their population dynamics.
Figures 2.4 and 2.5 show the population dynamics of a hypothetical
renewable resource, which we assume to be a single fish species. The xm.in

stock of fish (or biomass) is supposed to follow growth through time

as shown in Figure 2.4. This shows cumulative growth, or the size of 0 Tim~
the stock, as a function of time. At low levels of stock the fish multiply, XO
but as they begin to compete for food their rate of growth slows down Figure 2.4 Logistic Growth Curve of a Rer'.l!~~abk R~sourc~ where
nd
a eventually the stock converges on some maximum level Xe, the Stock Size is a Functwn ot 1 iml!.
 Rabindra N. Bhattacharya
64 Economi cs nf Nat
tiru/ R
esources
Growth we 111 ust harvest MSY every t h 65
ye ars, harvest f rom the resource and ent . Year
. on\y Msy
can
we . cr its long term stock. We get th
maintain t 1, the tn
i s sustainab·r . ost
doctno . . e maxim i ity with
re . lies an attraction m the idea of . urn from it ea h out
r1ere1n setting ou c period
r-.,1sY6 . However, we, shall see short\ h r rate of harve t .
10 nornically optimal policy. Y t at, Msy is un\ike~ equa\
an eco Yto be

!ENCY AND SUSTi\lNi\BLE YIELD

E,FFI C
tion to be efficient has to equate rn .
A\\oca (h . . . arg1na\ costs Of h
·nal benefit t at ts, max,m,ze net b arvest with
1_ de the costs as we as the benefits ass enefits)
11arg1 11
.
and h
. ence must
inc 1u . . oc,ated with h
resent purpose we ignore discounting and d fi arvests. For
Figure 2.5 Relationship between Resource Stock and Growth. our p·nable yield . It is the catch (harvest) I e ,\ne the static-efficient
sostat eve that if .
tually ' would produce the laroest annual b ' maintained
it will increase in the first year by G(X 1). ln the next year the population P •ent sustainable yield will incorporate ct·net enefits
erpe . . . . t:o Dy .
. · · • namic-
efti1c1 . 1scountmg 1
level of X 1 + G(X 1) will grow by less than G(X 1), but the growth Will entrate on static concepts and properties. · nit,a11Y we
cone .- . . . .
still be positive and the process will continue ~ntil the stock is back to 1
our analysis, 1or s1mp 1c1ty w1\\ assume: (I) The
. . resource (fish) price
Xe. If, on the other hand, the stock temporarily exceeds Xe, it would . constant; (2) the margma1 cost of fishino effort 'to b .
be exceeding the capacity of its habitat (carrying capacity). As a result 1s . d ~ :, , e exp\amed
bseq uently) ,s constant; an (.,) the amount of ha .
su . . rvest per unit of
mortality or out-migration would increase until the stock settles dow~ effort expended ts proportional_to t~e size of the resource stock (that
within the confines of the carrying capacity of its habitat at Xe. is, the smaller the _fish population, m our present example, the fewer
Xmin, in the diagram, is known as the minimum viable population fish caught per unit of effort).
and represents the level of population below which growth in population We now introduce the level of exploitation or harvest or yield of the
is negative (i.e ., deaths and out-migration exceed births and in- resource . Following assumption (3) above, we write
migration). The reader can check that in contrast to Xe, this equilibrium y
is unstable . Here, once the stock moves away from Xmin no forces act X=E ("2.6)
to bring back the resource stock to a viable level.
With human intervention when catch (yield) level equals the growth or alternatively as
of the stock, it is known as sustainable yield. Here the stock size, the y
E=- (2.6a)
growth rate and, hence, the catch all remain constant. Thus, in terms X
of Figure 2.5, G(X 1) is the sustainable yield for resource stock X1. the bigger the effort (E), the larger the proportion of the stock (X) that
Figure 2.5 helps to identify a concept widely used (particularly by would be harvested (Y) . We rewrite (2.6) as
biologists). This is the maximum sustainable take (MSY), which occurs
Y = EX (2.7)
when the growth of the resource is at a maximum. In Figure 2.5 it is
G(Xm) corresponding to the MSY stock Xm . The apparent attraction of
MSY should be obvious: if we harvest the renewable resource in such , . ·) I·ar,,oer than growth would
'lt
1
is to be· noted that catches ,lharn:sb . dbt·
a way that we take MSY from the stock, it will regenerate itself and d b ustained They will lea to
possible in the short-term, but these cou \ not es d. t level less
we can get MSY again in the next time period, and so on. If it takes . . h t
reduced stock size and, eventually. ,t t es oc Ii. were drawn own oa
one year to regenerate, MSY can be harvested each year. If it takes ten than Xmm'. to the extinction of the species.
 Rabindra N. Bhattacharya Economics 0 r Nat
'1 uro/ R
66 esources
rate of harvest can be shown on Figure 2.5 To k 67
Then. tI1e _ ·. eep th yield (Y)
diagram simple. we assume that Xm111 - X0 . The choice of E v-;" e
detenm·ne the equilibrium harvest Y and the stock level X, tilat is ~\\
EX is equal to the growth of the resource and this is sh ,
w here . . own in
1
Figure 2.6 where E = E 1. ~his gives t 1~ harvest Y_* and the stock X* \Y
, m

An harvest level above Y along the lme E1X will mean that h · ''
y . bl e y1e
. Id Y* an d tI1e stock will dee\arvest '
·s 0oreater than the sustama ·
1 1ne to
X* A harvest level below Y* along E1X will be less than the .
· . Yield
through natural regeneration (growth) , and the stock will grow to
X* again.
0 L---~-- -·. ___
E,
Growth . EX
Ill
(G{x)).
Figure 2.7 Effort- Yield Function.
Harvest (Y)
y
m
.. . .... ..... . ·---
-~-
. rnaller resource stock and would be recorded
in s ft as a movement from
. ht to le .
Y*
ng .._, 0 w the effort-yield curve depicted in Fioure 2 7 be
t~ ' l F. : :, . can translated
. to costs and revenue. n 1gure 2.8, revenues !benefits) d
in . fh . . , an costs are
5
hown as functions o arvestmg (fishmg) effort Because th
fthe harvested resource (fish) is assumed to be .constant t elpnce (p)
X* X o . , ota revenue
c Stock (X) (R) from harvest (Y) 1s

Figure 2.6 Effect-Growth Equilibria. R= pY,

lt is easy to see that Y* , though sustainable, is not MSY. However,
by manipulating E we could set Y equal to E111 X at Ym, the MSY.
Introducing the effort level , thus, helps tis to determine the harvest and
stock level. But it does not allow us to indicate the efficient sustainable
yield. For that we need to introduce costs and benefits (revenue) into
the picture.
To introduce costs and revenues we transform Figure 2.6 into Figure
2.7 showing the relationship between the harvest (yield) and the level
of effort, that is, moving from (X, Y) plane to (E, Y) plane.
Figure 2.7 shows various equilibrium levels of yield (like Y* , Ym,
etc.) corresponding to various levels of effort (like E 1, E111 etc.), where
Em > E1 and so on . A little reflection will show that every effort level
on this figure corresponds a stock level in Figure 2.6 or 2.5 and Eo
corresponds to Xe, and Emax to X0 . Note that increasing fishing effort
(a movement from left to right in Figure 2.7) would, in Figure 2.6, result
and the shape of the revenue function has the same shape as that of the
effort-yield function of Figure 2.7 (which in its turn depends upon
Figure 2.5).
As sustainable levels of effort are increased. eventually a point is
reached (Em in Figure 2.8) where further effort reduces the sustainable
catch (yield) and revenue for all years. That point corresponds to the
MSY (Y m in Figure 2.7).
The net benefit is shown in Figure 2.8 as the vertical difference
between the benefit R = pY and costs, C = cE (the constant marginal
cost of effort times the units of effort expended). The efficient (optimum)
level of effort is Ee, where the vertical distance between benefits and
costs is maximized. ln other words, Ee is an efficient level of effort,
because it is where the marginal benefit (slope of the total benefit curve)
is equal to the maroinal cost (the constant slope c of the total coS t ~urve).
~ . . d can detennme the
Once the efficient \eve\ of effort 1s determine we
efficient level of yield from Figure 2.7.

I
f
 Rabindra N. Bhattacharya
68
Economics of Natura/ R
esources
Benefit s •t is not difficult to think of pr· 69
(Revenues)
,1,hile 1 1vately ow
vv • ate owners are not normal in oc ned fishing . h .
Costs pnv .
Jakes, . ally be international common-pr
ean fi sh · rig ts
eries. Ocean " h .1n
Costs: C "' cE tYPIC operty· 1is eries
(113)' exercises control over. Because n , resources no .
R( E) rrnan o sole , single
(Jshe
h be It are conferred to any owner, no sino1 fiProperty rights to th
. . th e, e !sher e
(ls fi om explo1tmg e resource. This h rnan can rest .
hers r c aracterize net
ot s resources. s free (open)-
C(E) acceshat could be the consequences when access to th
Benefits: R "' PY W try) is completely unrestricted? Free- e resource (fishery
fores 1· . . access reso
or . ds of externa 1t1es (T1tenberg, 19 98 )· ( ) urces generate
0 ~----.:----~=---~E---. wo ktn . h . b b . 1 a Conte
t lity wh1c 1s orne y the current . rnporaneous
Ell E, Effort (E) terna ' . generation It •
ma., ex O t'on due to overcommitment of resourc . · involves
noes I es to fishin
co
b0 ats,
too many fishermen, too much effort As g-too rnany
Figure 2.8 The Efficient (Optimum) Sustainable Yield for a . · a conseque
Renewable Resource (Fishery) en earn a substantially lower rate of tu nee, current
fi herrn . re rn on th ·
is An inter-generat10nal extemality which is b eir effort.7
Is, then, the MSY efficient? The MSY is efficient (in a timeless static (Z) tions. It occurs because over-fishin o reduc ornhe by the future
0uenera e, es t e stock f fi
world) only if the marginal cost of effort is zero. At the efficient level h' h in turn lowers future profits from fishin o (o . 0 1sh,
w 1c . e, nee, in the p
of effort this (zero) marginal cost has to be equal to (zero) marginal effort level exceeds that assoc~ated with the MSY). rocess,
benefit and marginal benefit is zero at the MSY level only. Because this When access to the fishery 1s free, an incentive to e d
is not oenerally true, the efficient level of effort (Ee) is less than that each fisherman beyond Ee reduces profit to the fishery asxpen effort
a whole. Eveby
necess;ry to harvest MSY (E 111 ) . Hence, the static efficient level of effort One imposes a burden on every one else. At the efficient le ry
leads to a larger resource (fish) stock than does the MSY yield level of fis herman (boat ) w1·11 receive · a profit equal to its share of th veI, each .
rent However, th:s . rent serves as a stimulus
. for new fishenn e scarcity
effort and MSY does not appear to be a socially desirable objective to · . . . en 1o enter
strive for. driving up c~st~ and ehmmatmg the rent. Hence, open access result~
in overexplo1tat10n of resources.

MARKET, FREE (OPEN) ACCESS AND COMMON

PROPERTY SOLUTIONS
Having identified an efficient allocation of a renewable resource (fishery),
we can now consider a competitive market allocation and compare these
two allocations. A competitive sole owner is supposed to have well-
defined property rights to the resource. A sole owner would want to
maximize his profit. This will occur (ignoring discounting again) at an
effort level where marginal revenue equals marginal costs. Clearly, this
is effort level Ee, the static-efficient sustainable yield . This will provide
positive profits equal to the difference between R(Ee) and C(Ee)- In the
absence of any extemality, maximizing net profits and maximizing net
social benefits may be assumed to be the same thing, and hence lead
to the same result.
In a free-access resource, as stated above, the individual fisherman
has an incentive to expend further effort, until profits are drawn down
to zero. This occurs at effort level Er in Figure 2.8, where net benefits
are zero (R = C) . Contemporaneous externality manifests in too much
effort being expended to catch too few fish , and cost (C) is substantially
higher than it would be in an efficient allocation. In fact, many fisheries
and forests in different parts of India and elsewhere are currently
plagued by these kinds of problems.
A resource owner with exclusive property rights would balance the
use value against the asset value of the resource (that is, would consider
future flow of returns also) . When access to the resource is unrestricted,
exclusivity is lost. It is then rational for the individual fisherman to
7
Some areas of deltaic West Bengal and coastal Kerala are experiencingthis
Phenomenon.
 Rabindra N. Bhallacha,y 0 Economics nf Natura/ Re.1.ource~
70
71
. ., tlH~asset value, as he can never appropriate it 1.1 . c,ople of the less developed world ) F
J!!ll OIC . · ll S p10 ·
c~ssipate all the scarcity rent. . ces, iviil ds of P- . . orests p
el 11ee d oi I erosion, c1eanse the air and act , rotect us from
However, free-access harvestmg may or may not lead t 1 fti 11 s . · ' as the
. d I . . . . ot ic c:-;1· 000
ds a They play a crucial role in the ecol natural habitat
() 1• tlie .species. It de.pen s on t.1e natu, . . e of th.e spec ies 'and the· I1111q 1on o
f wildlife. h of our useful water. Table 2 1ogy o_f water~heds that
fllUC . · provides , h
id costs of harvest mg below the 111111,mum viabl e stock (X . encn L pplY . f such multiple benefits. · a sc ernatic
ai d' . d I. I .
l .4 or 2.5 ). The con 1t1on _un _er w 11c 1 extinction Will 11 1gtire
1111 in 1 · Is s 1 ·pt1on o
descr1
'·l ) tint effort is costless- effort 1s at E111 a, in Fiuure ? 7 occur a •
(' ' . ::, - · anct ti 1' TARLE 2.1
ooes to zero; or (b) harvestmg takes place at levels abov le Sloe~ GOODS AND SERVICES PROVIDED
::, . ·I . . I I . . . . c the i . , 13y FORESTS
rate of regen_erat.1on,. t 1a! 1s, ! 1e 1a1 v~st 1s n.0_11-sustarnable. The 1dlt1ra1
11
resource ext111ct1on 1s high 1f there 1s a cnt1cal minimui . sk of ~ _s_ _ _ _ _ _ _ _ _ _ _ _..:,S:.:_
. 11 s12:e of erv _::':·ce'..:'_s
population (X 111 in). the
Are free-access resources and common-property resources , ~ Soil conservation - - - -
concepts? Do they 11np . I .d . I
y I ent1ca equ1·11·bra? The answer is genera S)nonvn ;II 1ous pulpwood Prott.:ction and regulation of
water supplies
We have seen that free-access means . that no one owns the resourceYno. food (tubers, 11owers, seeds Amelioration of climate
access is open to al I and unrestricted. A common-propert . , and
• db Yie sour and gums) .
however, is one that 1s owne y a defined group of peo I ce.
community. It is possible that within this group members may e-s~y ~
. . 1· .
iiave lree
Non-edible oil
Medicines
Shelter from hot and cold winds
Absorption of dust and noise
access to the resource . But 1t 1s . very
. 1kely that the ::,nroup w·ill ct eve~ · fibres and 11osses Maintenance of the pool of
rules and norms of use, restrictmg the use that any one indi -0 _P genetic resources
8 VI Lia! IS
allowed to make of the resource. These rules are widespread 1 · Resins Habitat for wildlife
. . w1ere Recreation
common property exists; tribal control of woodlands in Arun 1 Lac
. II d . . . . ac 1al Tendu and other leaves Maintenance of aesthetic qualit,
community contro e 1rrrgat1on systems 111 many parts of India a11 d so·
of environment ·
on. The reason that such rules emerge is the cognizance of the fact ti
Bamboos and Canes
unr~str!cted use by each in~ividual is more likely to lead to resour~:
Fodder Maintenance of co 2 balance
extmct1011, adversely affectmg the welfare of everyone and perha
imposing an irreversible damage (cost) on future generations. In ten~:
Source: Anil Agarwal (ed.) (1992), Th e Price of Fores cs, p. lt. CSE.
ofFigure 2.8 we might expect a common-property solution to be generally
between the profit-maximizing solution and the free-access solution.
Although forests share many attributes with other renewable resources.
However, common-property solutions can break down if, for instance,
the defined group gets larger and larger because of population growth they also exhibit some unique features . Trees are commercially valuable
and in-migration. It may then pay any one individual to defect breakinu when they are cut and sold. However if not cut, like a capital asset.
ranks and maximize individual benefit at the expense of the res,ource and standing forests also provide a stream of non-timber environmental
the community's overall interests (Pearce and Turner, 1990). services (as mentioned in the preceed ing paragraph). Each year, the
forest manager has to decide about when to cut (harvest) a particular
forest stand. Unlike many other renewable resources, the time period
ANOTHER RENEWABLE RESOURCE: FORESTS between initial investment (planting) and recovery of that investment
(harvesting) may be quite long. Intervals of 25 years or more are
Forests provide multiple benefits (goods and service) to humans. Forests common in forestry. Furthermore, most of the environmental benefits
are the source of timber which serves a variety of human needs (including provided by the forest are positive externalities which normally cannot
be captured by the resource managers. This leads to ineffici ent
"Chapter 5 will take up these issues in detail. management .
 Rabindra N. IJha((acharya
72 Economics nf Natura/ Resnurces
73
In tlic subsequent brief discussion we sh al I explor h
. . . . .· e O\v ·c efficiency would imply that the opt .
ombrned with forest ecology to a111ve at an effiic· econ0"' ofll' ,ma 1 t,m tO h
can be C 1e111 111 ·•11, 1 i:;con uld be that age that max 1m,ze<; th c arve<;t
f ti ·s imponant natural resource. We first model the fTi . anagell) d wo · e present . 1
o 11 . I e ic1e111 ent is stan from wood . The quantum of the net b r: v,i ue of the
even-aoed homogeneous smg e stand (or clust decis· 1I1 efit . ene1 it from th
to cu t al1 O
. er of tr 'on t ben whether the land will be perpetually c wood
ssume that the forest provides only commercial v ees). If. rt e d 0n ' comm11ted 1O ~
we a . . aIuc of -re dePen s atural processes after harvesting. The present ore<;try
This model could then be used to 111d1cate how the muit · tilllbe efl ton t·ve model assume<;
. fl l . !pie v I t or I d alterna 1 ·
the forest resource shou ld 111 uence t 1e harvest mg dee' . a Ues of econ k . b h
. . 1s10 11 'W the s . [ramewor , 1t can e s own that discountin (
assume that once cut, trees w1 11 agam resurface costle · e also
· process. ss 1Y thr oug1i a In thIS I e of money) shortens the age when the t gd mcorporated
natural regeneration . e va u . . . s an is harvested
ill 11fll f zero discount rate 1mpl1es that the opportun·h, . ·
use o . I ,., cost of capital
1 he h refore, 1t pays to eave the money invested .
TR EE GROWTH AND HARVEST . o· t e . . m trees as lono
15 z;er '
me growth 1s occurring ..
and the value of timber ·,
.
. "
s mcreasmo 10
Volume, typically in cubic feet (cft) or cubic metres (cm3) . as so With a pos1t1ve discount rate. however th 1 "
. is the b . recess . . , e recs will be
of measurement of tree growth on a specific site. This mea as,s the P d s soon as more will be earned from the money f h
. of bar k and limbs) between thesure1nen1 is. rveste a . . romt e salt:
taken of the trunks (exc 1us1ve ha
. este d 111 . a financial asset at rater. . Is economic efficiencv, compat,'bl t:
a four inch top. Only standing trees are measured · those gr;turndp and ,n~ stainable forestry? According to one approach, sustainable forestr,
. ' un ed b v1th SU · 1· · d h ,
wind or age are not mcluded . Y \ ould imply harvestmg 1m1te to t e gro_wth of the forest. leaving the
Data, based on this measurement of volume, suggests that ev w of wood unchanged over some spec I tied period of time. Effie iencv
en-aged volume
tree stands follow a growth pattern as shown in Figure 2 4 or altern t· . ecessarily compat1'bl e wit· h t11·1s deti1111t1on
· · of sustainable forestry.,
· a 1vely 15 not n . . . . h
in Figure 2.5. When trees are very young growth is rather slo . . cy reqUires max1m1z111g t e present value. Maximizino the
. w in Effi1c1en . . · "
volume tenns, th?ugh the _tree may mcrease suffi_ciently in height. Then pres en t Value , in turn .mvolves, as shown above, . an implicit comparison
a period of sustamed, rapid growth follows. Ult1mately, with the agino the increase m value from delaymg harvest (basicallv becaust:
betwe en . . -
process growth slows down, stops or even reverses. :, of the growth in v_olume) and the increase 111 value from harvesting the
When should such a stand be cut (harvested)? Foresters adopt a . ber and investing the sale-proceeds to earn r. If the growth rate 10
biological approach to answer this question. They suggest a measure ~:iume is small (as with slow-growing species), maximizing the present
known as mean annual increment (MAI). The MAI is obtained by value may imply harvest volumes higher than the net growth of
dividing the cumulative volume of the stand at the end of each decade the forest.
by the cumulative number of years the stand has been growing up to It is interesting to note that the search for sustainable fo restry that
that decade. is also economically efficient has led to the emergence of rapidly
The biological decision rule then is: cut (harvest) the stand at the orowing tree species and plantation forestry (for example, eucalyptus).
age when the MAI is maximized. These species raise the attractiveness of replanting, because the invesced
money is tied up for a shorter period of time. These species are raised
ECONOMICS OF FOREST HARVESTING in plantations. Plantation forests with exotic varieties have _made mroads
into less developed countries like India. With low cost of planting and
To an economist, however, the above rule would appear somewhat replanting they are supposed to serve various needs, such as supplying
arbitrary. This rule ignores the factors that seem to play a crucial role
in an efficient harvesting decision. Some of these factors are, for pulp for paper mills, firewood etc. . dh
Plantation forestry, however, has raised many que st ions an . as
example, the value of the timber, the time value of money, the costs of • • · s of tree endangenng
planting and harvesting. An economic model of the harvesting decision become controversial. It mvolves a smg 1e specie .' . . .
. · I dino w1ldltte habitat.
would, however, incorporate the basic biology of tree growth shown in biodiversity so essential for many purposes me u " . h
. . d endan°enng growl
Figures 2.4 and 2.5. It also requires large chemical mputs an water, 0

L
 74 Rabindra N. Bhattacha,··
Ya
of other species around. rn Karnataka, a few
. . eucalyptus Years back, a Economics of Natura/
movement deve Iope d agamst p1anting Resources
Jt is instructive to note that thus far we ha · Do1i~1~ . 0 of natural areas is, in many 75
.
amenity values of a forest while determining . . Ve .
abst racted f· r versto d. cases a .
. . . . OPt11na1 . 1011
con demand for un tsturbed natural .' n lrteversibl
/f stand mg trees provide amenity services in pro . . rotat1 1 tl1 e d the . . • environ e Process
an i·ngful d1stmct10ns can be made b t lllent is grow· ,
h fifi .
it can be shown t at e 1c1ent rotation will b Por t1011 t ° 011 1en,
thei 1-v ~1~. rv1ean
d thoS e
.
that for all practical purposes a
'
e Ween
Uses that are re . ·
, re not C .
1ng too
versible
Bhattacharya, 1990). However, when amen,·ty e 1onoe ° r (Sn,,dOlli,lle an elopment of a water-storage reservo· ( · 0ns1der, for exarn
cannot be captured by the forest owner the p . va 1ue s are laro , er a,1d' dev ir Which h .
the done) at Neora valley near Kalimpong in If as 1n fact already
P1e,
may fail to take account of these values, leadi· nvate . rot at1on . de::ie . a_nd been the Silent valley of Kerala) which is a irnalayan West Bengal
, ng to rn r at . n ecolog·
rotation periods. e lcientlyc1s1
ffi h0n (o di·ng to the Zoological Survey of India th ica 11 Y fragile area
Accor . e area c0 . ·
Another point that deserves our attention h . . s 0rt "' . rsity with rare botamcal species and u . nta1ns valuable
·od1ve .. . nique gen f .
deforestation has been encouraged by a failure eti e .is that ineffic' bt ti·ng a dec1swn to build a reservoir invo!v e ic information.
0 incor correc . . es more tha ct·
Porate globen1
· 1
benefits from stand mg forests; by concession ands b .d cture when its existence begins to imp . n 1srnantling
.d . . h u s1 y aoree al the strU ose environ
prov1 e 111cent1ves to arvest too much and too quick! 0 111ents tha ceed the returns from development. Disma . mental costs
• • • . y and by ta x syste st that ex • n11 mg such a
tI1at d1scnmmate agamst standing forests . t som
e future time would, m many instances I
.
h
, eave t e area . h
structure
111
fn rndia, soon after independence in the fi . t fl a . ti·c base entirely different from that which· exi·st d . . . wit an
1 abJO . e m1t1ally. in the
growth , vast stretches of bamboo forests '
were leass d ush of industrial
·
natura
1 state. Once the natural habitat is destroyed
. f fl , we are likely 10
·11
1111 s.
Th · ·
e agreements required the mills to pay a royalty t e to paper and Pulp an entire species o ora and fauna for ever E .
0 I Jose · xamp 1es hke this
for the quantities of bamboo extracted. This royalty w ~ le government are many.
su bs1.d.1zed rate. Generous subsidies were also offered as tIXed.- at a hiol::, 1IY 'T'echnology can do little to reproduce the results of th
1 .
.
e particular
.mdustnes . I':ior I':iorest clearance and harvest. All these prompto diorest-bas d _ed ttem of geomorphology, weathering, and ecologi·cal su .
pa . . . ccess1on
of the I':iorest resource base. Lease of forest lands without ere t·estruct,on normally found 1~ the sce~1~ ~nv,_ronm_ent. To economists, the important
. . . ea 10n of any question about mevers1b1ltty is_this (Fisher, 198 J ): what are its
stake 111 the future product1v1ty of these lands has adversely affi d .
. . · ecte the implications for resour~e .allo_cat1on? If the in situ resources of an
regeneration potential of these areas. Such pol ices have not only d ·
epnved environment are appreciating m value, relative to goods and services
the government of revenue , but also encouraged unsustainabl
indiscriminate exploitation of the country's forest wealth. e, that it might yield if developed (for example, dolomite mining at Buxa
Tiger Reserve in West Bengal or harnessing water for electricity at Tehri
in the Garhwal hills of U.P.) then irreversibility will clearly pose
problems. Restriction on conversion, then matters, because value would
NATURAL ENVIRONMENT AS A NATURAL be increased by going back to an earlier less converted state, With the
RESOURCE AND IRREVERSIBILITY AND passage of time this is more likely to occur. . .
UNCERTAINTY IN ENVIRONMENTAL PROCESSES Processes of economic growth and technolog1cal change involve
important irreversibilities and asymmetries. We have stated earlier that
This section will deal with the preservation of natural environment, or, natural areas and their ecosystems generally cannot be recreated once
stated alternatively, with the al location of in situ environmental resources. disturbed by development. At the same time, it is also true that the
Stock of land as a natural resource is valuable not only for what could processes of technologtcal . change that have caused the oorowth .of output
be extracted from it but also for the opportunities it provides for are generally incapable of recreatmg . our stoc ks of natural environment.
experiencing natural beauty and solitude. fn this sense, areas of
undisturbed natural environments or ecosystems are treated as a That is technology is asymmet:ic. . d h above factors can
This situation is represented m Figure 2·9, andt e t·on frontier. The
component of natural resources. The natural environment component "ft . th ooreoate pro UC I
deserves special attention particularly for two important reasons: the be represented by the sh1 s '.n e a= 0 to ( ) to ()) represents the
shift of the production frontier from (1) 2
 76 Rabindra N. Bhallachary a Economics of Noiu,a/
Resources
~
effects of the reductions in amenities of natural env 1· ;JZENCES AND FURTH ER RE 77
. mnmem(x 1·
shifting left) and the effects of improved technol ogy incre
. · nterc ep1s
JtBf f_, ADINGs
ofordinary produced goods. Ifwe imagine a family of . ~sing ou"' A (ed.) (1992), The Price of Forest [) ,
. I I f . d. . social inct ·"" 'Pltt 11l"v 111• , · ( t 979), ' Scarcity and Growth R · clh, CSF,
curves ,(soc1a ana ogue. o m 1v1dual . indifferenc e curves) t11 1eren ce /\g ti h -1. h R cv 1s1tcd ·
grne , . and Growl evisited, Baltirn ·. · n V Kerry S
1

society s values, the. optimum pomts shift upward and to the Oft rene ct 13 5carc1IY 7 ore. Resources ~ . rn11h led )
I I 63-2 I · · or the F
the slope at the pomts of tangency represents the 11 . e • Sine pP· f-[ J and C. Morse ( 1963 ), Scarcity and G tilurc.
. . egat1ve of h e etl . . rowth B I .
of the pnce of natural environmental amenities to th t e ratio arn ' F wre. · a limore R
B the u . .. e,ourcc,
goods, we can see that this relative price (value) wouldat_of Produced for J ( 1997), Sustamabt!1ty and Environm E
r'· • ent cono ·
even w1·th no sI11·ft m · taste. Th ese observations imp! th nse ove r time, · 13owe,,.. ,
.,, uJ< •· Addison Wes 1ey Longman.
•
mies An ililernative
analysis and other planning procedures must take thy bat benefit-cost 1eX1~ i·n W. ( t 990), Mathemati cal Bioeconomic . Th
. e a ove trend . k CO I s. e Op1i I
ctar , vable Resources, 2nd ed., New York· w·i1 ma Managemem
account. . We. might reasonably expect project investm en t cntena . . into of Rene} d G M Heal ( 1979) E · . ey lntersciencc
ta, P. an ·. . . ' conom1c Theo a
such s1tuat1ons to be somewhat conservative. Under oasguP es Cambridge: Cambridge University Pre ry nd Exhaus11hle
Uncertainty also plays a crucial role here. Our kn I d Resourc , ss.
. . owe ge ab I 981 ), Resource and Environmental E .
. her A. ( conom1cs Ca b .
environmental assets and their processes is seriously incom I out ft 5 ' •dge University Press. · m ndgc
. . . P ete. We d0 carnbn
not kn ow the precise way m which the carbon and the h d . ick N.J. Shogren, and B. White ( 1997), Environ
·1 . . h y rolog1ca1 11a.nleY N ' UK menta1Econo .
eye Ies work . WI11 e 1t 1s. true . ,;.heory and Practice, : Macmillan Press. mies
. t at uncertainty will decline th roug h time
.
,n I..r, g H. ( 193 I), ' Th e Econom1cs . of Exhaustible Resourc ,
the natural world remams imperfectly understood. Thus assum · . ' Hote I tn , 39 137- 75 es , 1ourna/ of
. . ' mg nsk political Economy, , pp. .
aversion, there 1s good reason not to reduce natural environment ~~ 1
.
the benefits from domg so are known and are substantial. Howe, C·W· ( 1979), Natural. Resource Economics. Issues, Ana1ys,s. . p
olicy
New York : Wiley Intersc1ence. ·
Hy de, W•F· ( I 980), Timber Supply, Land Allocation · and Economi ·
c Effi1c1ency.
Washington DC : Resources for the Future.
Parikh , K.S. (ed .) ( 1999), India Development Report, 1999-2000, Delhi
Produced Oxford University Press.
Pearce, D. and R. K. Turner ( 1990), Economics of Natz1ral Resources and the
Goods
Environment, New York: Harvester and Wheatcheef.
Salant, s.W. ( 1995), ;The Economics of Natural Resource Extraction A
Primer for Development Economists', The World Bank Research Obserl'er,
February, pp. 93-111 .
Snyder, D. and R.N. Bhattacharya, ( ~ 990), ·A Mon: General Dyn~ic Economic_
Model of the Optimum Rotat10n of Mult1pk-use Forests . Journal of
Environmental Ec;onomics and Management, 18, pp. 168-75. .
Solow, R.M. ( 1974 ), 'The Economics of Resources or the Resourm ol
Economics', American Economic Revie1r. 64. PP· 1- 14.. . ·.
. 999) ·L k1 o Back to Thmk Ahead , Delhi.
Tata Energy Research Institute ( I , oo 11~ '
TERI. p I 2nd ed USA:
Titenberg, T. ( 1998), Environmental Econ omics an d O ,cy. ·•
Addison-Wesley.
0
Services of Natural Environment
.I

Figure 2.9 Irreversibility of Environmental Process and the

Asymmetry of Technological Change.
78 Rabindra N. Bhattacharya

REVIEW QUESTIONS
1. How would you explain the phenomen h
on t at th
resources seem to be becoming scarcer relat· e renewab
1ve to the le
resources? exhaustibl
2. The supply behaviour of a price-taking owne f e
O
resource d1·fi':1ers firom that of an owner of rordina an ex haustible
resources . Why? ry goods or
3. Establish the conditions that must hold wh ile d .
. ep 1et1ng
exhaustible resource along an optimal path. What would an
optimal depletion rules if a 'backstop ' is available? be the
4. What is meant by the term user cost? If user cost increases, what
happens to the level of harvest or extraction today?
5. Is economic effi~iency compatible with sustainable forestry? Defend
your answer.
6. Consider a fishery and derive the efficient level of yield. Is the
MSY efficient? Give your reasons.
7. Are free-access resources and common-property resources
synonymous concepts? Do they imply identical equilibria? Should
common-property resources in India be privatized? Explain.
8. Why would you expect project investment criteria to be somewhat
conservative under irreversibility and uncertainty in environmental
processes?