Natural Resource and Enviromental Economics

UNIT 1: NATURAL RESOURCES
Contents
1.0 Aims and Objectives
1.1 Introduction
1.2 Dynamism in Natural Resources Definition (Minerals)
1.2.1 Resource/Reserve Classification
1.2.2 Stock Resources and Flow Resources
1.3 Summary
1.4 Answer to Check Your Progress
1.0 AIMS AND OBJECTIVES
The aims and objectives of the unit is to introduce to students to what constitutes natural
resource and how they have changed over time. It deals with the issue of dynamism in natural
resource occurrences. It provides the major bases of resource of reserve classification.
What you will learn in this unit

- to understand what constitutes the natural resource base
- to define and identify major types of natural resource or reserve base
- to understand the dynamism in natural resource definition
- to understand the principles of a resource classification.
1.1 INTRODUCTION
What constitutes natural resources have changed over time in response to

- increased knowledge
- technical improvements
- cultural developments (demand for end products).
Even though the total physical endowment of the earth is fixed, resources are dynamic with
no fixed limits. History of resource use has been of continuous discovery, with an ever
widening definitions of resource based. Economically, resource is defined as an agent that
1
provides services to society. It provides life support for the survival of human life. More
elaborate definitions will be given in the next section.
1.2 DYNAMISM IN NATURAL RESOURCES DEFINITION (MINERALS)
1.2.1 Resource/Reserve Classification

A dictionary definition of resource "something in reserve or ready to be used if needed," has
been adapted for mineral and energy resources to comprise all materials, including those only
assumed to exist, that have present or anticipated future value.
Resource - A concentration of naturally occurring solid, liquid, or gaseous material in or near
the earth's crust in such form and amount that economic extraction of a commodity from the
concentration is currently or potentially feasible.
Original Resource - The amount of a resource before production.
Identified Resources - Resources whose location, grade, quality, and quantity are known or
estimated from specific geological evidence.
Identified resources include economic, marginally economic, and sub economic components.
To reflect varying degrees of geological certainty, these economic divisions can be
categorized into measured, indicated, and inferred. The terms proven, probable, and possible
which are commonly used by the industry in economic evaluations of ore or mineral fuels in
specific deposits, have been loosely interchanged with the term measured, indicated, and
inferred.
Demonstrated - A term for the sum of measured plus indicated.

Measured - Quantity is computed from dimensions revealed in outcrops, trenches, workings
or drill holes. Grade and quality are computed from the results of detailed sampling. The
measurement is spaced so closely and the geological character is so well defined that size,
shape, depth and mineral content of the resource are well established.
Indicated - Quantity and grade and (or) quality are computed from information similar to that
used for measured resources, but the sites for sampling and measurement are farther apart or
2
less adequately spaced. The degree of assurance, although lower than that for measured
resources, is high enough to assume continuity between points of observation.
Inferred - Estimates are based on an assumed continuity beyond measured and indicated
resources for which there is geological evidence. They may or may not be supported by
samples or measurements.
Reserve base - That part of an identified resource that meets specified minimum physical and
chemical criteria related to current mining and production practices. The reserve base includes
those resources that are currently economic (reserves), marginally economic (marginal
reserves) and some of those that are currently sub economic (sub economic resources).
Reserves - That part of the reserve base which could be economically extracted or produced at
the time of determination. Reserves include only recoverable materials.
Marginal economic reserves - That part of the reserve base which borders on being
economically producible. Its essential characteristic is economic uncertainty. Included are
resources that would be producible, given postulated (anticipated) changes in economic or
technological factors.
Economic - This term implies that profitable extraction or production under defined
investment assumptions has been established, analytically demonstrated, or assumed with
reasonable certainty.
Sub economic resources - That part of identified resources that does not meet the economic
criteria of reserves and marginal reserves.
Undiscovered resources - resources, the existence of which are only postulated, comprising
deposits that are separate from identified resources. Hypothetical and speculative resources
are under this category.
3
Exhibit 1: Major Elements of Mineral Resource Classification
IDENTIFIED RESOURCES
Cumulative
Demonstrated
Production Inferred
Measured Indicated
ECONOMIC Reserves Inferred Reserves

Source:
Principles of a
MARGINALLY Inferred Marginal Reserves Resource/Reserve
Marginal Reserves
ECONOMIC Classification, U.S
Geological Survey 831,
1980
SUB Demonstrated Sub Inferred Sub economic
ECONOMIC economic Resources Resources
Other Occurrences Include Non-conventional & low grade materials
Note: Resource of any commodity (name), a reserve (mine) in a field, regions, district…
1.2.2 Stock Resources and Flow Resources

What are the major types of resources. One is stock (non renewable) resource, the other one is
flow (renewable) resource.
Stock resources - stock resources are resources that are consumed by use which includes all
the fossil fuels.
The current rates of consumption affect future availability. The key question is what is the
optimal rate of use over time?
Flow resources - Resources that can be renewed within a short time span to be useful to
human beings.
Under flow resources, you have critical zone resources and non-critical zone resources.
Critical/ zone resources - critical zone resources can be exploited to exhaustion. An example
of CZR are biological resources and soils and aquifers.
4
Non-critical zone resources - non critical zone resources (NCZR) are resources that remain
renewable irrespective of human activity; some can be depleted temporarily by overuse.
Land - land is a fixed stock although it has a renewable capacity to support all forms of
biological life. There is natural regeneration of soil fertility when the land is not under
intensive cultivation. The supply of land available for reproductive purposes can be reduced
by urban developments - which is referred to as sterile use.
Exhibit 2: Resource Classification

STOCK RESOURCES FLOW RESOURCES
Consumed Theoretically Recyclable Critical Zone Non Critical

by Use Recoverable zone
Oil All Metallic Fish Solar energy

Gas elemental minerals, Forests Wind, waves
Coal minerals, copper Soil Water
potash Water in Aquifers Air, tides
Animals
Flow resources used Critical zone resources become stock

To extinction once regenerative capacity is exceeded
Stock resources (all minerals and land) are substances which have taken years to form and are
in fixed supply. There must be a limit to the quantity which can be used. The stock resource is
not homogenous, there is a distinction between those which are consumed by use and those
which can be recycled. The theoretical approach as to the optimal rate of use over time (of the
stock consumed by use) considers a perfectly competitive market system which sets out
conditions under which an optimal depletion path can be achieved for each individual stock.
Of the flow resources, the critical zone, the depletion process might be advanced that natural
recovery of the supply flows fails to occur, even if exploitation has ceased.
5
Check Your Progress Exercise
1. What are the major types of natural resources?
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
2. Describe the principles of a resource classification.

___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
1.3 SUMMARY
The basis for the mineral resource classification are varied and include major economic
divisions. These economic divisions are categorized into measured, indicated and inferred.
Measured is the term for actual quantity which is calculated from dimensions as demonstrated
or known in working sites or drill holes. Indicated refers to quantity of the cumulative
production with high degree of assurance of occurrence to assume continuity. Inferred is the
term for estimates which are based on assumed continuity of production which may have a
geological evidence. Stock resources and flow resources are the major types of resources
under the category of general resource classification. The stock resources, otherwise known as
non-renewable resources are known to be consumed by use. Land belongs to this category,
but it has a renewable capacity. Under flow resources, although known to be generally
renewable, you have critical zone resource (CZR), which can be exploited to exhaustion
depending on the intensity of human economic activity. Non-critical zone (NCZR) resources,
on the other hand, can be renewed within a short time span.
1.4 ANSWER TO CHECK YOUR PROGRESS EXERCISE
1. Refer to sub section 1.2.2

6
UNIT 2: RESERVE AND EXHAUSTION
Contents
2.1 Introduction
2.2 Proven/Indicated Reserves
2.3 Conditional Reserves
2.4 Economic Exhaustion
2.5 Summary
2.6 Answer to Check Your Progress Exercise
The aims and objectives of the unit is to familiarize students with physical and economic
exhaustion of resources. It indicates how proven or indicated reserves change due to specific
variables. It shows how the market forces determine the onset of economic exhaustion.

- to understand what actually limits the spatial location of proven reserves
- to understand the dynamic variables that affect the level of proven reserves
- to understand the concept of the onset of economic exhaustion.
2.1 INTRODUCTION
Deposit which are considered to the economically viable should have reserve levels that
yields higher net return on investment. However, this would impost a limit on the number of
reserve site. Besides, indicated or proven reserve levels depend on a number of dynamic
variables, such as the level of technological knowledge and skills. There is an indication that
economic exhaustion occurs much more rapidly than the physical depletion of a mineral
deposit.
7
2.2 PROVEN/INDICATED RESERVES
Proven reserves are the deposits already discovered and known to be economically
exploitable under current demand, price and technological conditions. For instance, a
company may regard deposits economically viable reserve levels that yields 10 - 20% net
return on investment. This limits the number of proven reserve sites. Profit requirements of
producers varies between private companies and government producers. To prove reserve
levels, there is a need for expensive surveys and test borings.
Proven reserve levels depend on the following variables:

1. The level of technological knowledge and skills
2. Demand levels, whole range of variables (pop. Income)
3. Production and processing cost. This is determined by the physical nature of the deposits,
location, etc. Add to this the cost of production and level of government taxation.
4. The price of the resource (product) - This reflects the level of demand and the supply
costs. In this category, we consider pricing policies of producers, which in return is
affected by government intervention.
5. The availability and price of substitutes, including the cost of recycled products. Technical
breakthrough stimulates increasing supplies and falling of prices. Further technological
changes would help expand the range of uses to which oil could be put, for instance.
Demand would thus be increased. It is now possible to commercially exploit deposits
lying at depths in areas unheard 20 - 30 years ago.
Spatial Variations
The above five variables also affect the location of proven reserves.
2.3 CONDITIONAL RESERVES
Deposits which have already been discovered, but not economical (viable) to work at current
price levels with currently available production technology. The least developed countries
(LDCs) should have ores with higher grades, for instance, copper ores with 10% metal
content, to counterbalance lack of infrastructure (high cost) and stability.
8
2.4 ECONOMIC EXHAUSTION
The onset of economic exhaustion

MCn
MC3
D
MC2
MC1 MC
Cost/Price
P DP
O Output
MC - MCn MC/supply curves at different point in time

D-D Total market demand curve
P - DP Demand curve faced by perfectly competitive firm
Notation
The above graph illustrates the role of market forces in determining when any particular
mineral deposit reaches the point of exhaustion. As the deposit becomes more (physically)
difficult to mine, supply costs rise, and overtime the MC supply curves (MC - MCn) will shift
upwards.
 The producer will need to get higher prices for each unit of output to cover the
production costs
 But, as prices rise, fewer consumers will be willing or able to purchase the commodity
(mineral).
 If deposit accounted from all supplies reaching the market, the producer is faced
(with) by the market demand curve (D - D). Some production will be sold until at
MCn cost levels; no output can be produced at that price.
9
 If the deposit is a minor contributor to total supply the producer faces the demand
curve P - DP; output can only be sold at market price.
 Therefore, in these circumstances economic exhaustion occurs much more rapidly, and
by the time the supply costs have shifted to MC2 there is no demand for the mineral.
 Economic factors (explains) do nothing to prevent local economic exhaustion, as
compared to worldwide physical exhaustion of resources.

1. What limit the number of proven sites?
___________________________________________________________________________
___________________________________________________________________________
2. Discuss the onset of economic exhaustion.
___________________________________________________________________________
___________________________________________________________________________
2.5 SUMMARY
The limits to the number of proven or indicated reserves are established by the action private
companies or government producers which set the reserve levels rate of return on investment.
The higher the rate of return on investment, the lower the number of proven reserve sites
which may be regarded as not economically viable. Proven reserve levels depend on the level
technological knowledge and skills, demand levels, production and processing cost and the
price of the resource. The onset of economic exhaustion occurs as the deposits become
physically more difficult to mine and supply costs rise and the supply curves move upwards.
The supply costs in this regard are good indicators an earlier onset of economic exhaustion
finally, the question is whether the economic factors, such as demand, supply and prices do
present local economic exhaustion of resources.
1. Refer to sub section 2.2

10
UNIT 3: RESOURCE SCARCITY AND IMPLICATION FOR DEVELOPMENT
Contents
3.1 Introduction
3.2 Fears of Scarcity
3.3 Absolute Physical Exhaustion and Technological Innovation
3.4 The Market Response Model
3.5 Summary
The aims and objectives of this unit is to introduce the notion of the fears of scarcity, the
polarized scarcity debate. It indicates the rile of technological innovation to postpone the
absolute physical exhaustion. It illustrates how diminishing returns (output) per labor input
have been postponed due to technological innovation.

- to understand the view of both pessimists and optimists with regard to resource
scarcity
- to understand the relationship between absolute physical exhaustion and technological
innovation
- to understand the market response model as response to resource scarcity
- to know the challenges to optimism.
3.1 INTRODUCTION
To the economics economic scarcity occurs when the quality demanded is higher than the
quantity supplied at the going price. The widely held view that there was an imbalance
between what is available and the future demand for essential resources is still the cause of
the polarized scarcity debate. One of the arguments provided by the optimists was the notion
11
that technological innovation seems to have been able to postpone the occurrence of
diminishing returns.
3.2 FEARS OF SCARCITY
The Poralyzed Scarcity Debate

The widely held view - there was an imbalance between the availability of essential resources
and future demands for them. Stock resource scarcity was viewed as a major barrier to
continued economic development. Fears of scarcity are not new. Malthus is 1798 on
"Principle of Population" testify the case; there is a mineral law governing the relationship
between population and resources. Given fixed (limited) resources deposits would be used
first, in which case increase in consumption would he met by exploiting inferior (outlying)
stocks. Productivity would fall as increasing inputs of labour and/or capital are required to
produce additional unit of output.
Engel's View
Forty years later, Engels stressed the labor productivity and the ability of man to utilize
science and technology to provide for this needs.
3.3 ABSOLUTE PHYSICAL EXHAUSTION AND TECHNOLOGICAL INNOVATION
Before absolute physical exhaustion occurs, marginal physical product starts to fall and
diminishing returns (output) per labor input set in. Meaning, resources exploitation costs
would rise in real terms, measured by factor inputs prices required to maintain output.
However, technological innovation appears to have been able to postpone the occurrence of
diminishing returns.
12
Illustration
Increasing output
T22
Outpu
t
Declining output
T1
0
Labor output
Diminishing Returns and Marginal Physical Product Curves
The curve represents the MPP of the labor used in mineral exploitation, shifted upward and
outward overtime from T - T2.
Conclusion
Pessimists were assuming that response mechanisms did not exist or would act too slowly, the
optimistic school would argue that the market system would respond automatically to prevent
severe exhaustion problems - causing stock resource scarcity.
13
3.4 THE MARKET RESPONSE MODEL
Figure 3.1 The market response to resource scarcity.
Scarcity
Extraction cost rise
Prices rise
Demand decrease Supply increase
Increase use of Increase use of

substitutes, more substitutes, more
recycling recycling
INNOVATIONS
Development of new Search for now

substitutes, deposits
development of development of
improved conservation methods to increase
methods, improved the output from
recycling techniques known sources
The Market Response Model

The market response model is a theory of the idealized market response to resource scarcity as
developed by the market optimists. In a market economy the price of a resource commodity
which is scarce would rise. The increased production costs along with diminishing returns
would force producers to supply less. The price rise would trigger demand, technological and
supply responses (Figure 3.1). Initially demand decrease as consumers look for cheaper
substitutes or introduce economic use or other conservation measures. Considering metals,
14
demand for the primary resource falls as recycling scrab becomes more valuable. Secondly,
the price rise and fears of scarcity would provide an incentive for innovation. The
technological changes increase the availability and decrease the cost of substitutes and
improve conservation methods. These changes will feedback through the price mechanism to
cut demand and reduce the pressure on the original scarce commodity. Thirdly, the price rise
will make it economical to exploit unviable deposits, encourage exploration for new supply
sources and promote development of new extraction technologies to increase yield from
known deposits. Furthermore oil demand is known to be price sensitive as the reduction in
world consumption since 1973 demonstrates.
The optimists do not only argue that falling demand will slow down the rate of exhaustion,
but also state that such decreases should not imply reduced living standard or declining rate of
economic growth. Hence, substitution will become key demand adaptation mechanism.
Resources have no intrinsic worth, but derive value from the useful services or products they
yield. Thus, if other methods can be found to perform these same functions at no extra cost,
then real incomes and growth rates should not be affected.
Substitution can take a variety of forms. Direct substitution occurs when one resource
commodity replaces another. For instance, aluminum, stainless steel and plastics are all
substitutes for copper. Plastic piping in household plumbing and utilities is another example.
Another form of substitution occurs when the need for specific resource products or services
is reduced by the substitution of technology. The use of fiber wires replaced copper wires in
communication technology. A third form of substitution involves the increased use of scrap
for a number of metals - recycled old scrap. Substitution occurs when lifestyle or demand
changes alter the mix of find goods and services. For instance, the change from an economy
based on heavy industry and primary production to one which is less resource intensive is a
case in point (advanced nations).
Challenges to optimism:
- The market system is imperfect
- The results of market operations may not agree with the social, economical and
political options of society.
- The market cannot cope with some forms of natural resource scarcity.
15
1. What do you understand by the polarized scarcity debate?
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
2. Discuss the market response model.
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
3.5 SUMMARY
In conclusion, pessimists were assuming that the market response mechanism did not exist.
On the other hand, the market optimists would argue that the market system would come to
the rescue to prevent exhaustion that causes stock resource scarcity.
The market response model is the market response to resource scarcity developed by market
optimists. The price rise of a scarce commodity (resource) would stimulate demand,
technological and supply responses. The fall in demand would slow down the rate of
exhaustion and development of new substitutes would be encouraged with new technology.
Substitution, thus will become the major demand adaptation mechanism. One of the
challenges to optimism is the fact that the market system is imperfect.

16
UNIT 4: RESOURCE AND POLICY
Contents
4.1 Introduction
4.2 Attributes of Resource Management
4.3 Interventionist Measures
4.3.1 Trade Regulation
4.3.2 Taxation
4.4 Summary
The aims and objectives of the unit is to introduce to the students the need of policy in
resource management, the decision and action by and for society. It indicates the
interventionist measures required to control trade and production which are vital to any
resource producing country.
What you will learn in this unit is

- to understand the attributes of resource management
- to understand what the interventionist measures are and their impact on export and
import
- to understand the effect of regulation of domestic energy prices.
4.1 INTRODUCTION
The resource-related decisions are very complex. Resource allocation policy problems are
also complex as they occur in an intricate physical and biological system and should be dealt
within a complex social and institutional environment. Human beings face many challenges in
the management of resources. Consider land resource and water resource. Most of the
economic activities, be it production, consumption or waste disposal require these resources.
17
Governments as keepers or prosecutions of public interest or the general will should come out
with policy. So long as government serves the public interest, it may seek to establish and
implement policies which are good for society.
4.2 ATTRIBUTES OF RESOURCE MANAGEMENT
The philosophical bases of policy: policy denotes decision and action by and for society,
usually by some authority (government). Effective policy in any country will be determined
by
- whether the government chooses to intervene
- which interventionist measures are adopted
- how these measures are implemented in practice.
The political power of the mineral corporations lies in their success in convincing that there
interests are vital to economic efficiency, growth, employment generation, healthy trade
balance or security (social objectives).
Any decision will influence people in general whose interest and well-being will be affected
one way or another. According to Randall, resource-related decisions initiated by public
decision making bodies are made within institutional structure that defines and attaches legal
rights and liabilities and establishes structure for incentives. This indicates that any resource
utilization or allocation policy problems or management issues for that matter, are quite
complex, and require or should be solved within an intricate social and institutional
environment.
4.3 INTERVENTIONIST MEASURES
4.3.1 Trade Regulation

The regulation of trade flows over an international boundary.
Export Tariffs
Export tariffs are imposed by LDCs, as a revenue-raising measure and to encourage the
establishment of domestic processing industries. (Governments lack bargaining skills, fiscal
and management skills).
18
- Specific export taxes - fixed amount per unit weight that provide stable income; but
leave windfall profits to the companies to enjoy when prices are high.
- Ad valorum tariffs - these are royalties set as a percentage export value, meaning
putting additional percentage charge on sales of ores at prices above a set baseline
figure.
Import Tariffs
Import duties (premium or tariffs) used as revenue-raising devices.
Non-tariff barriers
These are physical constraints on trade, which include import and export quota, total import
bans, export embargoes, and import regulation. Sudden imposition of quotas or embargoes
can have a major impact on resource trade and consumption patterns. A typical example is
OPEC's 1973 trade embargo.
All consumer nations favor the import of crude minerals and the establishment of local
processing plants.
For LDC producer countries export controls become key policy measure. In the past some
imposed restrictions force price increase as a measure of conservation, i.e., brings about a
slower rate of resource depletion, spread revenue receipts over time and reserve mineral for
domestic use (needs for the future).
Trade Promotion Measures

Government institutes measures to stimulate trade. It gives favorable loans, direct trade
subsidies, tied aid (industrialized nations) to increase export. It also promotes counter trade
deals such as pure barter, counter purchase or buy back.
4.3.2 Taxation
Output Taxes - Royalties or Severance Taxes
These taxes are specific levy per unit of output or a percentage of the value of production. In
case of windfall royalties, governments take higher percentage when prices exceed base
figures.
19
Profit Taxes
These are taxes on net income or profits. According to basic economic theory, they should
have an adjusting advantage for a revenue - concerned government, without affecting output
levels. AC and MC production are not affected, nor is demand.
D
MR MC
AC
P
Z
Q
Y
MC D
MR
0
X Output
D – D Demand curve for the mineral
MR – MR Marginal revenue earned from the sale of each unit of output
MC – MC Marginal cost of producing each unit of output
AC – AC Average cost of producing each unit of output
Total Profit
Government Tax
Figure 4.1 The Theoretical Advantage of Profit Tax
Assume that an imperfectly competitive firm (Figure 4.1) to maximize profit is producing OX
units of output.
- To sell output OX units, price OP would be charged to consumers.
- A price in excess of OQ produce pure profit.
- PQ profit is made on each unit of sale, total profit of the firm is represented by the
rectangle QYZP.
20
The government could take all of it without affecting output.
As Cobbe (1979) finely put it, the elegance of formal models produces, as a result of
necessary simplifications, conclusions at variance with common sense and experience.
- The problem is we are dealing with firms with several supply sources (metal) in
different countries. Output will be taken from the country with the lowest profit tax
levels.
- The decision to invest in new capacity will be affected by the tax. So, governments
should be careful about their profit take.
- For metals basic profit tax are in the range of 35 – 50%, more for non-nationalized oil
ventures. But, since about 1970, governments have introduced extra windfall profits or
excess profit taxes to increase their take in period of high profits. The practice has
been widely adopted by such countries as Zambia and Canada.
- Due to these excess tax schemes has increased the profit share of the host nations. This
was particularly obvious in the oil case. Malaysia had, for instance, managed to get
98.5% share in total profits.
Capital Value Tax

This type of tax is predominantly to be found in the industrial economies. This involves
taking the value of the property owned by a company rather than the production or profits.
There are two forms of this value tax: annual tax and capital gains tax, both affect mineral
extraction and exploration.
Annual tax is levied on the value of the proven reserves held by a company. If this is imposed,
then the rate of depletion of the existing reserves should increase, while the level of
exploration to prove new deposits would fall.
Capital Gains tax is imposed (or in operation) a company would become liable for taxation on
the sole of an asset which has increased in value, after making allowance for all expenditure
incurred on it. This might discourage investment in mineral deposits as compared to other
ventures (assets) exempted from capital gains tax. In practice, where it is in operation, it
might be considered as a source of conservation (McDonald 1967).
21
Tax Concessions
The practice of the holidays and other forms of incentives undoubtedly attracted foreign
investment in LDC producer governments. A high rates of return were achieved from some
resource extraction ventures. However, controversy over tax incentives remains both in LDC
and industrial economies.
4.3.3 Price Regulation

Simple economic models dictate that mineral and energy prices are set by the forces of
demand and supply. In actual practice, the situation is different. A typical example is the
pricing practices of producer cartels, such as OPEC (price fixing operation). Consumer
governments have imposed some control to regulate domestic energy prices. For instance,
holding price above ‘free’ market rates. Essentially, the imperfections within the market have
brought about further imperfections through government regulation.
4.3.3.1 Regulation of Domestic Energy Prices

Major consumer governments have taken specific steps to regulate domestic energy prices.
The degree of control, the methods used and the objectives have varied between countries and
within one nation at different periods of time. What are the major justifications for regulation?
- To protect consumers and the competitive position of manufacturing, exports prices
have been held below market rates.
- This was directed against local (indigenous) energy producing monopolies or
oligopolies. But, later on, regulation has been employed (recently) to combat the price-
fixing operations of OPEC. The existence of imperfections within the market have
bred further imperfections through government regulation. The imposition of price
controls affects the profitability of domestic producers. Strict imposition on private
concerns becomes self-defeating, because exploration and development activity
decline, supplies are constrained and prices will need to increase to restore demand –
supply balance. On the other hand, an imposition on nationalized concerns would
result in conflict between the consumer protection objective and the desire to maintain
rates of return on capital and levels of employment in the controlled industry.
- To maintain price levels above market rates. This is to protect local energy producers
from low-priced foreign competition and the need to promote energy conservation, for
22
balance of payment and supply security reasons. There is always the problem of
reconciling measures, such as import taxes, quotas or bans, value added taxes, which
increase price, with consumer protection and manufacturing competitiveness. Because
of such problems, West European countries have witnessed an ad hoc shits in the
direction of public intervention in energy prices. Periodic price restraint to combat
inflation became more common specially in late 1960s. The development of North Sea
Energy sources further complicated the conflict. In general, price decisions have
reflected the policy agenda of the period, be it inflation control, reducing nationalized
industry losses, unemployment, the balance of payments or economic efficiency. In
other countries, after the oil crisis of 1973, oil prices were being established by
government bureaucratic administration.
4.3.4 Subsidy
Public subsidies, such as for the maintenance of employment in uneconomic industries and
the provision of low-priced goods and services are sources of inefficiency within the
marketing system.

1. What are the interventionist measures imposed by governments?
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
2. Discuss price regulation.
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
4.4 SUMMARY
It is indicated that government intervention in the production of minerals has wider

implications. Effective policy decisions are made by governments which influence the trade
and production patterns. Some changes in the distribution and resource development have not
23
resulted from government activity, but from the response by the international mineral
corporations. It cannot be assumed that government regulation will mean that mineral
industries will operate in line with the general will or public interest. Considering domestic
price regulation, that is, energy price, consumer governments have taken measures to regulate
domestic energy prices.
1. Refer to section 4.3

24
UNIT 5: ECONOMIC EFFICIENCY
Contents
5.1 Introduction
5.2 Efficiency Concept
5.3 Efficiency in Production
5.4 Efficiency in Consumption
5.5 Allocative Efficiency and The Pareto Efficiency Criteria
5.6 Summary
The aim of this unit is to introduce students to efficiency concept. It explores the idea of
efficiency in production, efficiency in consumption and allocative efficiency.

- to understand the concept of economic efficiency
- to understand the concept of pareto efficiency
- to know the difference between efficiency in production and efficiency in consumption
- to understand allocative efficiency and the pareto efficiency criteria
- to explore variations of the pareto criterion
5.1 INTRODUCTION
The term efficiency has a wider connotation. It encompasses pareto-efficiency. The concept of
pareto-efficiency does not stop at production and consumption efficiency. It goes further to
include consumpers' preferences, meaning, what is to be produced should depend on
customers choice. Considering efficiency in production, the underlying assumption is that
producers would operate at a minimum cost levels in order to survive. Efficiency in
consumption explores the range of possibilities of product substitution and their relationship
with product price. The relationship between allocative efficiency and pareto efficiency would
25
be discussed. It is understood that for pareto efficiency to occur certain necessary conditions
must be stated. Moreover, to have a complete picture of the analytical process, the grand
utility frontier should be identified. Besides, variation in paretian criteria would be dealt with.
5.2 ECONOMIC EFFICIENCY
In static analysis of efficiency, we consider five major objectives or criteria against which the
results of the resource production system can be evaluated. These are economic efficiency,
distributive equity, economic growth and employment generation, supply security and
environmental quality. The term efficiency is not limited to economic efficiency (in this
material), but also to Pareto-efficiency (named after the philosopher and economist Vilfredo
Pareto). Pareto efficiency is synonymous with global efficiency. It involves efficiency in
production and efficiency in consumption. Moreover, Pareto-efficiency also implies what is
produced should depend on consumers’ preferences, in addition to resource availability and
technology.
In this sort of analysis, we ask how prices are established by individual’s independent
decisions. Furthermore, we will understand how efficient resource allocation and commodity
distribution depend on these prices.
To illustrate this notion, a simple model of a whole commodity might be constructed. The
economy in the model consists of two consumers, two products and two inputs. This permits
us to use two-dimensional diagrams.
Thus, the production functions are:

B = Pb (LbDb)
W = Pw (LwDw)
Where Lb = the amount of labor used for the production of bread, and D b = the amount of land
used for the production of bread. Lw and Dw are similarly defined for wine. The underlying
assumption is that production technology is constant and B, W, L and D are homogenous in
quality.
26
Plus, the utility functions are:
U1 = f1 (B1W1)
U2 = f2 (B2W2)
Where U1 = the level of utility enjoyed by the consumer 1 and U 2 = the level of utility enjoyed
by consumer 2. The underlying assumption is that the tastes and preferences of each
individual remains the same. Furthermore, it is assumed that marginal productivity of each
input in the production of each output is diminishing, and so also the marginal utility of each
consumer from the use of each commodity.
5.3 EFFICIENCY IN PRODUCTION
If a given level of output is produced using least-cost methods of production, then the industry
is said to be technologically efficient. Competitive firms will seek to achieve this; otherwise
as inefficient producers, they would fail to be profitable and would not survive. That is, in a
perfectly competitive situation, the assumption is that individual producers would have to
operate at minimum cost levels in order to stay in business. In theory, in the longer term the
entry of new firms into the industry, plus the competition from substitutes would force the
industry to produce using least-cost methods. However, in practice, no such assumption can
be made about private firms with enough market power to determine their price and output
levels (partially at least).
The existence of monopoly, cartels, vertically integrated concerns, long-term supply contracts,
price fixing agreements removes efficiency condition. (Products from, and the services of
their own companies will be employed at the secondary production stages).
Factors that suggest that non-minimum-cost operation can be maintained over a period of
time.
- Natural, technical and artificial barriers to entry of new competitive firms
- Multinationals control the output of the whole range of substitutes
- Firms maintain output at high-cost centers to reduce risk by maintaining a diversity of
production centers, to minimize supply interruptions.
27
Note: The production Edgeworth Box and the production efficiency locus-which is the locus
of all possible combinations of inputs that are efficient in the production of two commodities
– provides a theoretical analysis of production efficiency.
5.4 EFFICIENCY IN CONSUMPTION
Product-choice indicates that the goods and services produced must reflect consumer
preferences (if the firm wants to remain in business). This follows the notion that consumers
are sovereign, preferences for goods are established exogenously and producers just respond
to consumer requirements. In reality, however, producers manipulate consumer demand by the
influence of advertisement.
Furthermore, consumer choice is constrained by what is made available, known as availability

constraint. And consumer choice is also constrained by what consumer durables or capital
equipment have already been purchased, which is known as contingent preference constraints.
For instance, goods with short lives, with obsolence built into them have to be purchased if
more durable (quality) products are not marketed or available. And households can not switch
to alternative energy sources if an expensive energy supply system is already installed (such
as centrally heating system).
The theoretical analysis of consumption efficiency for any selected product mix on the
efficient production possibilities curve, the consumption efficiency locus represents a locus of
efficient commodity distributions. Thus, the consumption efficiency locus is a locus of points
of tangency between indifference curves, and at any point on it, the slope of the tangent to the
indifference curve for consumer 1 must equal that of consumer 2. Therefore, the following
condition must hold at any point on the consumption efficiency locus: the rate of commodity
substitution between two commodities for consumer one must equal that for consumer two.
That is,
28
(RCSx, y)one = (RCSx, y)two
Efficient production
possibilities curve
Xd d= O2
Consumption
efficiency locus
X
I1two I3one
I2one
I3two I2two
I1one
Point d defines a production mix.

Figure 5.1 Derivation of the consumption efficiency locus
5.5 ALLOCATIVE EFFICIENCY AND THE PARETO EFFICIENCY CRITERIA
Efficiency Criteria
Allocative efficiency is concerned with the entire distribution of factors of production and
goods and services within an economy.
Pareto efficiency is defined as a situation in which everyone is well off that it is impossible to
make anybody better off without making at least one person worse off (simultaneously). In
effect, pareto-efficiency is a situation so efficient that it is impossible to reallocate resources
or redistribute commodities in order to make things more efficient.
To complete our analytical process in our search for pareto-efficiency, the grand utility
frontier should be identified. The Grand Utility Frontier is the outermost boundary of the
feasible section of the utility possibilities diagram. This line joining the outermost segments
of the various utility possibilities curves is not a true curve, but a frontier or envelope curve.
29
At any point on the grand utility frontier the following condition is true - it is impossible to
reorganize the economy in such a way as to make one individual better off without making
another individual worse off.
Grand Utility
Frontier
Utility of
Two
Utility Possibilities
Curves
0
Utility of One
Figure 5.2 Utility Possibilities Curves and the Grand Utility Frontier
All points on the grand utility frontier are pareto-efficient. However, points that lie outside the
outermost curve are inefficient.
Necessary conditions for Pareto-Efficiency

There are three conditions necessary for Pareto-efficiency:
- efficient resource allocation
- efficient product mix
- efficiency in consumption
Efficient Resource Allocation:

It is the rate of technical substitution of any pair of inputs that should be equal for all firms in
the production of all commodities and should be equal to the ratio of the prices of the inputs.
That is,
(RTSD, L)x = (RTSD, L)Y = PD
PL
for all firms.
30
Efficiency Product Mix:
The rate of product transformation of any two products should be equal for every producing
firm and it should be equal to the ratio of product prices.
(RPTY, X)firm 1 = (RPTY, X)firm 2 = PY
PX
Efficiency in Consumption:
The rate of product substitution for any two products should be equal for each consumer and
it should be equal to the ratio of product prices:
(RCSY, X)1 = (RCSY, X)2 = PY
PX
Departures from Pareto - Efficiency:

Anything departing from perfect market conditions result in violation of the necessary
conditions for pareto-efficiency. Examples of such deviations include monopoly and
governmental actions (subsidies). In the real world most decisions cause some people to gain
at the expense of others. For this reason, variations of the Paretian Criterion have been put
into practice, such as compensation rule (Kador-Hicks 1939).
The Compensation Problem

Modification of Pareto definition. Under Kaldor-Hicks formulations, most resource allocation
would make someone worse off, but this was not a barrier to efficiency - goes the argument.
Further analysis indicates that if the gains made by some people are great enough to allow
them to compensate the losers, then the new distribution of the factors of production, goods
and services is considered as more allocatively efficient. The basis of the compensation rule is
shown diagrammatically.
31
Z
Consumer B
Marginal Utility
Consumer A
E E
0
Y Quantity of product X
Figure 5.3 Marginal Utility Curves & the Compensation Rule (demand)
Assume that consumer B has OX units of product and consumer A has nothing.
- The value B places on an extra unit of product has shrunk to zero (extra units X
beyond dark-shaded point, but to A it is worth OZ.
- If just one unit was taken from B and given to A, B's loss would be minimal (black
area) and A could easily afford to make up his loss out of his gains (dotted area) and
still be better off.
- This process of reallocation and possible compensation could go on until XY units
have been transferred from B to A.
- And the value of the product is now equal to for both consumers (EE).
- No further compensation payments are feasible; an optimal allocation of the product
has been achieved.

1. Describe Pareto-efficiency, efficiency in consumption and efficiency in production.
___________________________________________________________________________
___________________________________________________________________________
2. What are the conditions necessary for Pareto-efficiency?
___________________________________________________________________________
___________________________________________________________________________
32
5.6 SUMMARY
The static analysis considers economic efficiency, distributive equity, economic growth and
employment generation, supply security and environmental quality as important criteria
against which resource production performance should be evaluated. The notion of Pareto-
efficiency indicates that both consumption efficiency and production efficiency are part of
Pareto-efficiency concept. Besides, producers should respond to consumers requirements.
This is the implication of Pareto-efficiency. Allocative efficiency deals with the efficient
distribution of factors of production and goods and services. The necessary conditions for
Pareto-efficiency are efficient resource allocation, efficient product mix and efficiency in
consumption. The grand utility frontier is the outermost frontier of the feasible area of the
utility possibilities curves.
1. Refer to section 5.3, 5.3, and 5.4

33
UNIT 6: PROPERTY RIGHTS AND RESOURCE UTILIZATION

6.1 Introduction
6.2 Property Rights
6.3 Property Rights and Economic Efficiency
6.4 Short-Term Future Effects
6.4.1 Known Mineral Deposits
6.4.2 Exploration Sites
6.4.3 Information From Exploration
6.4.4 Environmental Damage From Extraction
6.5 Economic Policy
6.6 Summary
The aims and objectives of this unit is to introduce to students the concept of property rights
and resource utilization. It indicates the short term effects of property rights and regard to
exploration sites, extraction and resource use.
What you will learn in this unit:

- to understand the different characteristics of property rights
- to understand property right and economic efficiency
- to understand the short-term effects of property rights on resource utilization.
6.1 INTRODUCTION
Property rights will be dealt with in the context of the implications of different institutional
structures. What kinds of economic organization are conducive or appropriate to the
achievement of efficiency? The other question is, what should be the crucial role of property
rights in the economy? The specific characteristics of the set of property rights should be
indicated. The different requires of property rights and the implications for economic
34
efficiency will be considered. The short-term effect of property rights on known mineral
deposits and other variables will be discussed. The effect of various economic polities for the
exhaustible resources would be explored in this unit.
6.2 PROPERTY RIGHTS
In understanding the concept of property rights define property rights, the notion of
institutional structures should come to the forefront. Property rights indicate the relationship
among people with respect to resource utilization and specify the penalties for violating
relationship. Then, what are the characteristics of a sufficient set of property rights?
Ownership:
Ownership is a legal concept that assigns the right to use. In competitive economy based on
the concept of private property, payment results in ownership. Ownership denotes the right to
use, subject to different restrictions. One type of ownership is exclusive ownership which
indicates the rights to use and to determine who else may use under different conditions
(specific).
Specifications of Rights: Exclusiveness

For exclusive property rights to achieve their intended purpose and to be effective, property
rights must be specified. This is crucial in terms of resolving conflicts between owners and
non-owners. Thus, it is important that rights that go with ownership must be specified
including the restriction that apply to owners.
Transferability:
In terms of effectiveness when engaged in any economic activity in allocating resources and
resolving conflicts requires that rights must be transferable. Restrictions on the transfer of
rights, as opposed to restrictions on use, are causes of inefficiency. Such kind of restrictions
pose hindrance to the achievement of equality between price ratios and the specific rates of
substitution and transformation. Furthermore, efficiency calls for the ownership rights
pertaining to land be transferred. This allows leasing, renting and other rights of way to make
land utilization more efficient. For instance, if an individual buys land, the individual acquires
35
certain specified rights to use that land. This is what is called the transfer of the right to
remove and use.
Enforcement:
To be effective, a system of rights must be enforceable. An un-enforced right is not right at all.
The specification of rights should include the specification of penalties for their violation.
Therefore, enforcement guarantees that penalties will be imposed in the event of violation.
6.3 PROPERTY RIGHTS AND ECONOMIC EFFICIENCY
The concept of property rights specify the relationship among people with respect to the use
of resources and penalties for violations. Natural resource utilization under the following
property rights will be considered.
- State property (regime)
Ownership and utilization controlled by the state. Consider state-owned forests,
national parks and mines.
- Private Property
Ownership and utilization as well as the right to buy and sell controlled by individuals
private forests.
- Common Property
A group of owners can control the use of resources, by excluding others. Common
land and pasture.
- Open or Free Access
The potential user has an autonomy to utilize the resource - no one has legal right to
exclude others. International water fishing and wildlife harvesting.
Stock resource creates economic surplus - economic rent - which is the difference between the
market price and cost of extraction or harvesting. In case of private or common property, there
is an interest of the utilizer to manage and harvest the resources carefully. Individuals have
incentives for careful management or conservation of the natural asset, and they maximize
economic rent from resource utilization. What is the resource policy implications?
36
6.4 SHORT-TERM FUTURE EFFECTS
Institutions and policies may influence the costs of discovery, extraction and resource use.
That is, raw materials prices and the rate of resource extraction. Talking about property rights,
considerable number of rights are involved, such as rights to known deposits, exploration
sites, information from exploration and environmental damage from extraction. Let us
consider them one by one.
6.4.1 Known Mineral Deposits

In a situation where mineral deposits were subject to res nullius (non exclusiveness) situation,
only the extraction costs would be considered by minerals. User costs would belong to
society, and the res nullius situation would not permit royalities or rents to rise above zero.
With competitive extraction, price would equilibrate at
P = MEC.
6.4.2 Exploration Sites

Considering a situation in which again res nullius applies to exploration sites - but the
resources discovered were by finder-keepers. Excessive and duplicate exploration activity
occur, as firms rush for undiscovered minerals (acquire) and convert them to their own
privately owned resources. Extraction would be accelerated.
6.4.3 Information from Exploration

With tenure rights to sites, firms that produce information from exploration (valuable
information from exploration (valuable information that reduces the cost of further
discoveries) would gain value from others who would be willing to pay for it. What happens
if exploration information becomes non exclusive? The cost of exclusion could be high (No
benefit).
6.4.4 Environmental Damage From Extraction

Extraction (using of raw materials) causes nonexclusive environmental damage. The
exploitation of natural resource as raw materials for industrial production involves the
exploitation of the environmental resources. Resources such as water, air quality, plant and
animal life and landscape value have been treated as free goods with no market value. Stock
37
resource production and consumption require the services of environmental resources.
Extraction involves disruption soils, vegetation and drainage. It produces considerable amount
of water and air pollution and reduces landscape values. In the energy sector, accidents during
extraction can cause great environmental damage and loss of life.
6.5 ECONOMIC POLICIES
What would be the effect of interest rates which is influenced by the general economic
policies, and specific tax, or subsidy policy (directed) for the exhaustible resources sector?
Higher interest rate on the exhaustive resources, increase the rate of extraction. It also requires
a rapid growth rate of resource rents which in turn drives down current rents and the asset
value of reserves. Property tax increases the rate of extraction, that lowers the price of raw
materials and lowers the rents accoruing to the owners. A property tax on unmined minerals
(reserves) forces the owners to reduce tax bill by reducing the reserve. A severance tax is paid
on each unit extracted. The price of raw materials is increased, whiles extraction and MUC
are reduced.

1. Define property rights.
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
2. Discuss the specific characteristics of a set of property rights.
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
6.6 SUMMARY
Property rights are defined as a set of rules that indicate the relationship among people in the
context of resource utilization, that includes also penalties for violating the relationship. The
characteristics of property rights are ownership, exclusiveness, transferability and
38
enforcement. Ownership is a legal concept that indicates the rights to use. Exclusiveness
denotes specification of rights including restrictions. Transferability deals with the transfer of
the rights to remove and use. Enforcement guarantees the specification of rights and penalties.
The different property regimes influence the management and utilization of natural resources
in various ways. Property rights, such as rights to known deposits and exploration sites would
have greater impact on the rate of extraction. State property, private property, common
property and open or free access-all have different and specific approach to resource control
and utilization.

39
UNIT 7: NON-RENEWABLE RESOURCES
Contents
7.1 Introduction
7.2 Market Processes and Non-Renewable Resource Use
7.2.1 Optimal Extraction Path (Depletion Path)
7.2.2 Hotelling Rule
7.2.3 Parameter Changes and U-shaped Time Path
7.3 Summary
The aims and objectives of this unit is to introduce to the student the concept of market
processes and the use of non-renewable resource. It indicates the optimal extraction path and
Hotelling Rule.

- to understand the market processes as it is applied to non-renewable resource use
- to define optimal extraction path or depletion path
- to understand the concept of the Hotelling Rule
- to understand the parameter changes and U-shaped time path
- to define sustainability with regard to non-renewable resources.
7.1 INTRODUCTION
The contribution of the market process to sustainable extraction path will be discussed. If it is
assumed that the market is working under perfect conditions, individual private firms will
automatically produce the optimal allocation of resources over time. The Hotelling model and
the prediction of rising real prices of exhaustible resources will be dealt with in line with the
notion of the optimal depletion parameter changes and the effects on the Hotelling price path
40
will be explored. Could prices and costs serve as indicators of scarcity? This is another issue
which will be discussed along with sustainability requirement for non-renewable resources.
7.2 MARKET PROCESSES AND NON-RENEWABLE RESOURCE USE
It must be asked whether the market process as such will lead to a sustainable extraction path,
that is, will it leave enough resource stocks for future generations or does it divert from an
appropriate path? Emphasis is made that intertemporal resource - allocation decisions for
natural resources are made based on the question whether to exploit now or to conserve for
later use. Current decisions made help determine opportunities in the future.
7.2.1 Optimal Extraction Path (Depletion Path)

Subject to certain conditions, the extraction path induced by the market economy aims for
sustainability, because an increase in prices will gradually result in a more economical use of
resources once the resource stocks come closer to exhaustion (depletion). This is called an
optimal extraction path.
7.2.2 Hotelling Rule

Consider the exploitation of a known and finite stock of a non-renewable resource. An
optimal extraction path is one that maximizes the present value of the net benefits from
extraction subject to the constraint that cumulative extraction cannot exceed the initial stock
of the resource. An optimal path is characterized by three necessary conditions. First, the
marginal static benefits of resource extraction must equal its marginal costs. Marginal costs
consist of extraction costs and an opportunity cost which represents the fact that future
exploitation opportunities are reduced if the resource is extracted today. The opportunity cost
has frequently referred to as the user cost or the in situ value of the resource. The second
condition refers to dynamic efficiency. The resource stock is viewed as an asset which
generates a rate of return that needs to be compared to the returns from other assets. Asset
market equilibirium requires that the return to holding a marginal unit of the resource is equal
to the returns from any other asset considered. The return to other assets is measured by the
rate of interest, which is treated as exogenous in a partial equilibrium context. The return to
the in situ resource stock comprises capital gains and the marginal net benefits from holding a
unit of the resource stock. Capital gains comprise increases in the user cost of the resource.
41
Marginal net benefits from holding the resource stock are generally referred to as stock
effects. They arise, for instance, if extraction costs increase as the resource stock declines.
Holding one more unit of a resource stock then represents a benefit because it leads to lower
extraction costs. The third condition is transversality condition. It implies that, at the end of
the time horizon considered, the remaining resource stock is either exhausted or worthless,
that is, its in situ value is zero. In other words, efficiency requires that the entire resource
stock is used up as long as it is valuable. If the time horizon is infinite, the transversality
condition implies that the present value if the in situ value of the resource stock converges to
zero in infinite time.
In the simplified case where extraction costs are zero and stock effects are absent, the first
condition implies that resource price is equal to its user cost. The second condition implies
that the in situ value of the resource price also rises at the rate of interest. This result is
referred to as Hotelling's rule. Both conditions together imply that the resource price also rises
at the rate of interest. If the demand structure is stationary, the quantity extracted declines over
time at a rate that depends on the properties of the demand curve. If the transversality
condition is fulfilled and the time horizon is infinite, the resource stock is exhausted in infinite
time.
However, demand may decline to zero if the resource price increases beyond a threshold level
(choke price). This case occurs when a substitute becomes available at a cost equal to the
choke price. Under the perfect foresight and in the absence of stock effects, the transversality
condition now requires that the resource stock is exhausted exactly when the resource price
has risen to the choke-price.
An increase or decrease in the interest rate shifts the pattern of resource extraction to the
present or future. In simplified case without extraction costs or stock effects, an increase in
the interest rate raises the rate at which the in situ value of the resource increases (second
condition). This would imply a faster decline in the extraction rate compared to an extraction
path that starts at the same initial value of the user cost but is governed by a lower rate of
interest. However, the implied path is not optimal because it violates the transversality
condition. With a higher interest rate, an optimal path requires a lower initial value of the user
42
cost, which implies that resource extraction is higher initially than it would be under a lower
interest rate.
7.2.3 Parameter Changes and U-Shaped Time Path

The conditions on which Hotelling's rule is based do rarely prevail in reality. Technological
change can reduce extraction costs, which makes it profitable to extract more resource units
than if extraction costs were higher. As a result, the resource price may fall over a certain time
interval. Ultimately, however, rising in situ values cause the resource price to increase again,
which gives rise to a U-shaped time path of the resource price. Change in extraction
technology is one of the reasons why the historical prices of non renewable resource have not
increased continuously over time.
One of the most important prerequisite for Hotelling's rule to be valid is a precise idea of a
given known resource stock or at least of a given probability distribution of future exploration
possibilities. The more uncertain this probability, the lower the certainty of rising prices in the
future, and, consequently, the lower the tendency to restrict exploration of the resources
known today in order to profit from rising prices later. In addition, the resource owners today
might depend on a high income in the present and might not be in a position to postpone the
income into the future. Another important reservation about the validity of Hotelling's ruel, in
its basic form, is that it ignores capital costs. Given the capital intensity of mineral extraction
activities, capital costs have a strong impact on the evolution of resource prices and output
which can alter the conclusions of the basic model. If capital is an input into resource
extraction, changes in the interest rate have contradictory effects on the time path of
extraction. As discussed above, an increase in the rate of interest lowers the initial in situ
value of the resource. However, it increases the cost of extraction because it raises the cost of
capital. This gives rise to a non monotomic relationship between initial extraction and the
interest rate. If the interest rate is low and, consequently, the initial in situ value is high an
increase in the interest rate lowers the initial in situ value more than it raises marginal
extraction costs, which causes initial extraction to increase. However, if the interest rate is
high and the initial in situ value is low, an increase in the interest rate lowers the initial in situ
value less than it raises marginal extraction costs, which causes initial extraction to decrease
(Krautkracmer, 1998).
43
Furthermore, markets that are perfectly competitive at a point in time do not necessarily
ensure that the optimal exploitation paths described above are attained. In the case of non-
renewable resources, market processes ensure that the static and dynamic efficiency
conditions are satisfied. However, market processes do not guarantee that the transversality
condition is satisfied, unless a complete set of forward markets exists (Dasgupta and Heal,
1979). As a complete set of forward markets does not exist in reality, it needs to be
emphasized that markets for non-renewable resources are affected by an intertemporal market
imperfections (failure). As a result, the resource is either used up too early or a certain part of
the resource stock will never be exploited. This also applies to finite horizon situations.
Consequently, it remains open whether the market would take sustainability requirements into
account by a gradual increase in prices and a decline in extraction rates. Experience has
suggested the contrary so far. Over the centuries, relative prices of the non-renewable
resources on the whole tended to fall or remain unchanged at the most. Only in rare cases is
there an indication of a reversal in the price trend.
7.3 SUSTAINABILITY REQUIREMENTS FOR NON RENEWABLE RESOURCES
The main point to be raised whether rate of use is the adequate use of the non renewable
energy resources cover most of today's energy needs. The narrow definition of sustainability
suggests that the non renewable resources should no longer be used at all because they are not
renewable. Only this way could they be preserved on a sustainable basis. It is often demanded
that use of non-renewable resources may continue for the time being, but only if they are
gradually replaced by renewable resources. According to this concept, the use of renewable
resources will be increased at the same extent as stocks of non renewable resources decline. In
the end, when all non-renewable resources have been consumed, we will have to do with
nothing but renewable resources. However, this solution would only be satisfactory if the
renewable resources continue to be used in a sustainable way. Given the present structure of
production and consumption, this is fully impossible because the magnitude in which
renewable resources would have to be harvested is very high.
A way out of sustainable dilemma may be found if we decide to define a pattern sustainable
use specifically for non-renewable resources and to make this part of the whole sustainability
44
concept. Thus, in line with this logic, the following definition was suggested by some
authorities: non-renewable resources are used sustainably if their extraction is continuously
reduced to the extent that they are never fully depleted.
The extent to which extraction must be reduced depends, among others, on the size of the
stocks as compared to current production rate. In fact, the sustainable extraction rule for non-
renewable energy resources should provide a minimum standard. For instance, environmental
objectives, such as CO2 policies, may require their extraction rates to be restricted to less than
what may be considered as justified on the basis of scarcity.
If the sustainable extraction rule is set in such a way that the non-renewable resource stock is
exhausted in infinite time, this is consistent with several features of optimal paths in
neoclassical growth models. In these models, resource quantities extracted decline over time
and it is optimal to exhaust the resource stock in infinite time. Of course, the neoclassical
interpretations of sustainability rely on market processes.

1. Define optimal depletion path.
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
2. What do you understand by the concept of Hotelling Rule?

___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
7.3 SUMMARY
An optimal depletion path is defined as one that maximizes the present value of the net
benefits from extraction whereby cumulative extraction is limited by the initial stock. An
optimal path is characterized by the following necessary conditions:
45
- The marginal benefits of resource extraction must equal its marginal costs
- The resource stock is an asset which generates a rate of return which should be
compared to the returns from other assets
- The transvality condition which considers the remaining resource stock (the in situ
value) is exhausted or worthless in infinite time.
The conditions on which Hotelling's rule is based do not occur in reality. Due to technological
change extraction cost might be reduced and more resources would be extracted. This induces
a price fall over a certain time. However, the rising in situ value may cause the resource price
to increase again, which brings about a U-shaped time path of the resource price.
7.4 ANSWER TO CHECK YOUR PROGRESS

46
UNIT 8: RENEWABLE NATURAL RESOURCES
Contents
8.1 Introduction
8.2 The Concept of Renewability
8.3 The Fishery
8.3.1 Complications to the Analysis of Fishery Resources
8.3.2 Economics of Fisheries: Bio-economic Approach to Management
8.4 Open Access Fishing
8.5 Economics of Forestry
8.5.1 Optimal Rotation Model
8.5.2 Optimal Economic Rotation Period
8.5.3 Computation of Optimal Rotation
8.6 Renewable Natural Resources: Challenge to LDCs
8.7 Summary
The aims and objectives of this unit is to introduce to students the concept of renewability. It
gives a chance to students to get a good grip of the economics of fisheries and the economics
of forestry.

- to understand the concept of renewability
- to understand the sustainable capacity in fisheries
- to understand the economics of fisheries, a bio-economic approach
- to describe open access fishing
- to understand the economics of forestry
- to define optimal rotation model
- to understand the optimal economic rotation period
47
- to know the computation of optimal rotation
- to understand the challenges to LDC with regard to renewable natural resources.
8.1 INTRODUCTION
The main characteristics of renewable resources is identified and land as a fixed stock is
discussed as having a renewable capacity. In discussing water, as a flow resources mention
was made about balancing the supply of water and the rate of use. The concept of sustainable
capacity as applied to the fishery is explored in this unit. Mention is made to the
complications to the analysis of fishery resources. Bio-economic approach to fisheries
management is dealt with in this unit. Open access fishing and the control measures are
described here. In the economics of forestry, economic analysis as applied to forestry is
presented in this unit optimal rotation model and the optimal economic rotation period are
discussed here. The computation of optimal rotation is shown in this unit. Challenge to LDCs
- the renewable natural resource is discussed.
8.2 THE CONCEPT OF RENEWABILITY
The term renewable resource is used to include the highly diverse products of physical
environmental systems which are not classified as mineral stocks or fossil fuels. The main
characteristic of renewable resources is that they are capable of natural regeneration into
useful products within a time span (specified). This distinguishes them from fossil fuels,
which are transformed by use into forms of matter which cannot provide usable energy, from
the element minerals, which need to be reprocessed by society before use.
In the case of land, although a fixed stock it has the capacity (renewable) to support all forms
of biological life. the fertility of the soil regenerates naturally when the land is not used
intensively, or left follow. Similarly, in the case of water, there is a limitation imposed on
population, agricultural productivity or industrial activity by reliance on natural flows. Even
in temperate areas, huge capital investment is necessary to boost natural availability by
storage, recycling and the development of transfer networks. In this situation availability is
now a function of investment, and scarcity occurs due to lack of capital rather than absolute
physical flow limitations.
48
For many resources, the basic question (notion) is the balance between supply and the rate of
use within a defined area or territory, but not the overall availability and renewability within
the global system. That is, when use exceeds natural flow it is an area specific problem.
Storage and transport can adjust spatial and temporal imbalances between primary water
supply and use. The natural cleaning system can be accelerated by waste-water recycling and
the option exists to tap the massive potential of the oceans.
8.3 THE FISHERY
Sustainable Capacity:
The concept of sustainable capacity or yield is used when the physical potential of a
renewable resource is influenced by the requirement that its use must be allocated over time to
give equal opportunity to future generations. In the case of fishery, it is theoretically possible
to maintain a set yield of fish over time by controlling the level of exploitation effort.
Biological Model
Tonnage of fish Yield Per Annum
Maximum Sustainable Yield

X
Critical Zone
S Exhaustion
O Y Fishing Effort
OX = Maximum annual/yield consistent with sustainability

OY = Annual effort required to maximize sustainable yield
Figure 8.1 The Sustainability Curve Yield
49
At any point along the sustainable yield curve, the annual output is compatible with
maintaining the fish stock at a level which can produce the same output in future years.
When fishing starts, sustainable yield at first rises (as some of the competition for food is
reduced) allowing the rate of growth in the fish population and its biological productivity to
increase. However, if the fishing effort exceeds Y, the sustainable yield will start to fall until
critical point is reached, when the population becomes too depleted to reproduce itself. As
some resource economists have pointed out, the maintenance of sustainable yield is not a
costless strategy as it implies the reduction of current consumption.
Although it is easy to draw a sustainable yield curve on paper, it will not be easy to calculate
its real world dimensions. There is a great problem posed by lack of accurate data on the
maximum carrying capacity of the fishery, the size of the existing fish population impact that
might change the basic parameters.
8.3.1 Complications to the Analysis of Fishery Resources

Common Property:
By tradition, fishermen throughout the world regard the right to go fishing as one of
fundamental significance. The destructiveness of competitive fishing under open access
conditions is universally recognized. But, imposing a system of controlled property rights
have to be very difficult. Largely, the biological objective of protecting the productivity of the
fish stocks involved cannot be achieved without limiting fishing effort.
Complex Marine Environment:

Fisheries are subject to wide variations in yields as a result of changes in the complex marine
environment. These changes in yield-effort relations may reflect changes in the total number
of fish, their accessibility - i.e., concentration in schools, distance from shores- and
catchability. These changes in supply conditions make it difficult to plan fishing operations as
a more conventional business operation (constant state of short-run disequilibrium).
Data Problems:
The data required to assess and monitor marine fish populations are incomplete with respect
to the amount of effort expended and the location of fish catches. The other problem which is
50
a cause of inaccuracy is the multi-species fishery complex. Fish populations are linked
biologically, many commercially important species exist in predator - prey relationships. In
other instances, competition for common food sources or for space creates complex
interactions among fish stocks.
8.3.2 Economics of Fisheries: Bio-economic Approach to Management

Economic of fisheries deals with the problems in the natural resource utilization - fisheries.
The consensus among resource economists who have looked into the problems of fishery: one
area of concern is the fish stock - population with complex biological reproductive system and
the other is the long-term perspective policy issue (debate) between the maximum sustainable
harvest of fish population and efficient utilization (policy). The major issue in the nature of
fish population is that the fish populations are mobile, difficult to assign property rights to
individuals or even countries. The other issue is that fish stocks are harvested in situations of
open access fishing.
Economics of fisheries also deals with the analysis and development of public regulation
measures which guarantees sustainable harvesting policy and positive net revenue for the fish
industry. According to the biological model, a given fish population can be harvested on a
sustainable level (basis) by applying different harvesting or fishing effort. The traditional
approach to the utilization of fish resources is to apply the maximum sustainable harvesting
policy, i.e., full utilization of resources, gives (favorably) the largest possible material flow
that is sustainable over time, as indicated on the sustainable yield curve by "OY".
However, from the economic point of view, is the policy of maximum sustainable yield
optimal. As a capital asset, the fish population must yield a positive rate of interest, to yield an
interest an asset must grow - that is, the value of the raw material. And another reason for
keeping up a larger population size is that the stock may be valuable in situ. A case in point is
sea mammals have existence value, for instance, observational and photographic. Finally, it is
worth mentioning that economic analysis offers no instant cures, but it does suggest that the
root problem, the common property issue, must be resolved before any improvement in
economic and biological performance of commercial fisheries can be expected (achieving
economic gains).
51
8.4 OPEN ACCESS FISHING
This section deals with open access resource utilization and the problem of overexploitation.
The economic theory of an open access or common property resource suggests analytical
reasons as to why the tendency toward unsatisfactory rates of use of living marine resources
should be universal. When fish stock is harvested in open access situation, no fisherman can
be sure who will be the beneficiary from the value of the uncaught fish. In this situation, no
fisherman can conserve the resource by refraining from harvesting. This would only
encourage his competitors harvesting opportunities. This is what universally known as the
tragedy of free access harvesting. Under common property or open access conditions, the vital
link between the level of current harvest and the availability of fish in the future is hopelessly
missing. No individual fisherman or group of fishermen can control the current rate of
harvesting if the fishery is open to any new entrant. The yield that can be taken from a
population of fish depends on the rates at which new stocks are added to the exploitable
population, growth rates of the individual stock, natural mortality rates, and the rate of
consumption by society.
In less formal way, the level of exploitation of a marine fishery currently has a profound
impact on the size and aggregate weight of the fish will be available for harvesting in the
future. Given reasonable estimates of the biological functions mentioned above, the prices of
fish and the costs of labor and capital required, maximization of economic benefit from the
fishery would call for a level of fishing effort that would maximize the present value of the
stream of benefits available over time. A single owner of a fishery would find it not profitable
to mine the resource. He would, rather make sure that the productivity of the stock is
maintained and that the yield that can be harvested periodically (period by period) is
harvested at the lower possible cost.
However in the real world, new entrants build vessels and enter into the competition if prices
and costs make returns attractive. Thus, both theory and industry studies lead to the
conclusion that unlimited entry to fishery will result in over exploitation of the resource and
biological depletion of the fish stock. As a result the actual economic performance of a
heavily exploited, open-access fishery is fairly poor.
52
Then what prevents the finishing industry from destroying its resource base by harvesting the
fish population to extinction? The cost of over fishing a small fish population is high
(excessive amount of capital and labour for vessels and gears). Public intervention is
necessary to avoid the problem of overexploitation and achieve economic efficiency to a
certain degree.
8.4.1 Control Measures

Protection of the productivity of stocks (fish) can be achieved, in theory, by public fishery
regulation techniques.
Closed Seasons:
This is an attempt to limit harvesting during the crucial period when the fish population is
reproducing. This is also known as time closure.
Aggregate Catch Quotas:

This is a restriction to shorten the fishing period. The aim is to reduce the level of harvest to
the maximum sustainable yield, that is, to protect the stock from over harvesting. Other
control techniques include area closures, restrictions on more efficient types of vessels and
gear, and restrictions on the total amount of fishing inputs (labor and capital actually
employed).
However, theory and experience suggest that attempts to control total catch by any measure or
combination of techniques that still allow free entry to the industrial might be fertile exercise.
In conclusion, economic efficiency requires the annual harvest to reflect the true value of the
fish in the sea and harvest it at the lowest possible cost (avoiding large levels of redundant
capital and labor whose marginal value product is zero - not mentioning other goods that
could have been produced with that input - redundant). Moreover, in order for the economic
benefits from these resources to be maximized (including the in situ value), economic,
biological perspective along with appropriate property and regulation policy should be taken
into account.
53
8.5 ECONOMICS OF FORESTRY
The economic importance of forests in the lives of people in any region or nation is coming
increasingly to be recognized in many countries of the world. The role of forests in any
country depends on its natural endowments for forests, the state of its economic development
and on national aspiration. There are countries with relatively poor or limited forests where
wood for fuel is basic and scarce. Some of these countries are arid and never had generous
forests. Others have exploited their forests in the past, and currently have only very limited
supplies of wood.
Forests have certain biological and economic characteristics which affect the limits within
which forests may be established. Tree growth extends over a period of years - the period
from the establishment of the seeding until the economically optimum harvest date. There is
an earlier age of maximum average annual growth since establishment of the seedling or the
stand, and there is still an earlier stage of most favorable economic harvests. These are stages
on the growth curve.
The classic forestry model incorporates the establishment of a stand at one date, care for the
growth period, and then harvest, followed by another cycle. In this model, most of the
expenses comes at the beginning and all of the incomes come at the end. However, modern
forestry (plantation) is different in that more expenses occur during the growing life of the
stand, as more inputs are applied, and revenues are obtainable during the life of the stand by
thinning.
From an economic point of view, the most outstanding characteristic of forests is the large
amount of capital tied up in growing trees in relation to the annual additions to their volume.
In many countries, some or all of the forest-land is owned by the government, sometimes by
local governments. There is a widespread feeling in many countries that governments have
more concern for forest regeneration and for conservation forest management. Holders of this
view point to the slow growth rates of many forests and the low rates of return to capital,
which make conservation forestry most unlikely in private ownership. Some stress the ability
of governments to recognize the non-wood values of forests that are not appreciated by
private forest owners, and to manage the forests for both non-wood and wood values.
54
Economic Analysis Applied to Forestry
Economic analysis is fully applicable to forestry. Forestry presents difficulties for the
economic analyst like any other natural resource. There are some particular problems because
some of the outputs of the forests are not traded in commercial markets, hence it is necessary
to estimate shadow price for them. There are other special problems because the markets for
all forest products including wood are often imperfect in the economist's sense of the word.
There is a danger of treating this imperfect price as competitive price. There are also problems
of externalities of costs and values. There are other issues such as time dimensions, like costs
incurred at one time by one generation, values obtained at another time or by another
generation. Generally, forests are valuable natural resources which could be used for
individual or group economic and social benefit.
One major economic consideration is economic efficiency in forestry. How do the costs
compare with benefits? Economic analysis can be applied to publicly and privately owned
forests. Public resources or funds are costly in either the financial or economic sense.
Although all public decisions in different sectors have not always been guided by or
controlled by economic considerations, there is an increasing public awareness that the costs
should be estimated and compared with expected gains. The fact that some costs and benefits
do not find standard monetary expression does not make them that they do not exist. The
same concepts are extended to forestry.
Economic efficiency as applied to forests should be for the whole forest cycle, not merely for
the harvest of existing stands. Harvest for existing stands could be subjected to economic
analysis as part of a more extended cycle. The economic analysis must include the necessary
infrastructure or ancillary facilities such as transportation, communication water supply, waste
disposal and others. Economic analysis as applied to forestry must consider the costs incurred
and the benefits gained by private or public.
Economics should be applied to the productive process of wood growing. The economist who
analyzes forestry as an economic enterprise (forestry has moved into large-scale and
commercial enterprise) is dependent on the ecologists, the silviculturalists and other
biological specialists. An important component of the economic viability of a forest plantation
is the biological yields attainable. An important component of the economic viability of a
55
forest plantation is the biological yields attainable. Yields depend on nature, soil, climate and
other natural features.
World average forest cover is estimated to be 32%.

The traditional problems for forest economics are the optimal management of forests
regarding timber production (very narrow perspective), and when to harvest the stand of trees.
An optimal mix of all different services provided by forests should be found by society.
Different regions have variations in forest resources use. In Europe, timber production from
managed and plantation forests resource is increasing. Contrast this with the situation in the
tropical regions, deforestation is continuing at alarming rate (World Resource Institute, 1990).
As a result of this, the world will have reduced wood resources, intensify global warming and
erosion, and decrease in agricultural production and biodiversity.
8.5.1 Optimal Rotation Model

The growth, which is the Mean Annual Increment (MAI) of a tree in a stand depends on tree
species, its size, soil, density. This is sometimes referred as the mean biological yield of stand.
Young trees volume of growth is slow. The cycle starts with volume increase, stand matures
and then natural mortality occurs. One of the models used to determine the optimal harvest
time is the optimal rotation model.
The model considers biological point, meaning maximize sustained biological yield of forest
site (for chain of rotation).
- Maximizing the MAI of the forest stand, i.e., maximizing the physical timber
production.
- The rotation period that maximizes the physical timber production.
- At the age of the stand when MAI = CAI of a stand.
56
Compare this with sustainable yield curve for fish.
CAI m3/ha
MAI m3/ha
15
12
MAI
9
3
CAI
0
20 40 60 Tb 80
Age, Years
Figure 8.2 Maximization of Mean Annual Increment
MAI Mean Annual Increment
CAI Current Annual Increment
MAI Reaches its highest value at Tb . At this age, sustained biological yield of the
forest site is maximized over a perpetual chain of rotation.
CAI is higher than MAI before time Tb and lower after Tb.
Therefore, the rotation length that maximizes the physical timber production is at the age of
the stand when
MAI = CAI of the stand.
According to this biological model, the tree growth rate (CAI) starts to decrease when the
trees are about 50 years old.
57
Here, rotation length is determined from a biological point of view. Hence, forest policies can
be aimed at maximizing the physical timber production. At the stand level this means
maximizing the MAI of the forest stand. This is calculated by dividing the accumulated
timber volume by the age of the stand. In Figure 8.2, MAI reaches its highest value at time T b.
If trees are harvested each time when the stand reaches this age, then a sustained biological
yield of the forest site is maximized. It is possible to conclude (Figure 8.2) that the current
annual increment (CAI), that is the increment measured over a given time interval (a year), is
higher than MAI before Tb and lower after Tb. In essence, Figure 8.2 graphically depicts the
optimal harvest age of the stand if the goal is to maximize the physical timber production of
the forest site.
8.5.2 Optimal Economic Rotation Period

In the biological model, the aim was to maximize MAI. However, maximizing MAI is not an
economic solution. The problem formulation to find maximum MAI contained no economic
parameters. Furthermore, Tb is not the economic optimal rotation time.
Optimal economic rotation period answers the question at what age to harvest the stand, in
order to maximize the economic benefits over one rotation period. In order to find out the
OERP:
- There is a need to calculate the present value of the net revenue of planting and
harvesting the stand.
- The time for harvesting the stand should be the time that maximizes the present value
of net income over one rotation period.
- Allowing a stand to grow for an additional period means investing the current sales
value of the stand in the process of growing wood for one more period.
- Each year, the other alternative is to harvest the stand and invest the money elsewhere.
- So long as the CAI in the value of the stand is greater than the CAI of the returns on
the best alternative investment, harvesting must be postponed.
- Thus, the net present value of returns is maximized over one rotation by harvesting the
stand when the CAI of the value of the stand equals the CAI of the sales income
invested elsewhere.
58
The economic solution takes into account the cost of time (discounting). Therefore, the
optimal economic rotation period will be shorter than the optimal rotation when MAI is
maximized.
8.5.3 Computation of Optimal Rotation

To maximize the economic benefits over one rotation period, the stand should be harvested at
a certain age. The following illustration will help to find out the optimal rotation period which
is economically efficient. That is the optimal economic time for harvesting. Now we know,
for instance that the cost of planting (assume) is 5000 unit/ha, the timber price equals 150
units/m3 and the market interest rate is equal to 3%. The following data is also given:
Age Volume MAI m3/ha CAI m3/ha Timber Value ROI % Discounted Value r = 3%
(m3/ha)
20 4 0.2 6.9 600 1723 -4667.8
30 96.5 3.2 11.3 14467.5 11.7 960.4
40 222.7 5.6 13.7 33408.0 6.2 5241.5
50 363.0 7.3 14.1 54442.5 3.8 7418.7
55 432.1 7.9 13.5 64814.1 3.1 7753.3
56 445.5 8.0 13.3 66829.1 3.0 7766.8
57 458.8 8.1 13.2 68817.0 2.9 7763.7
60 497.3 8.3 12.5 74592.0 2.0 7668.7
Table 8.3 Volume /MAI/CAI/ROI and discounted value
Source: Valsta, 1992. Volume Development of a Spruce (Species)
According to Table 8.1, the undiscounted value of the stand increases as long as the tree
continues to grow. In line with the biological model, the CAI, the tree growth rate starts to
decrease when the trees reach 50 years old. At this age the CAI of the money invested in
growing trees is greater than the CAI of returns on other investments. Harvesting must be
postponed. Why should the trees be harvested when the CAI in the value of the stand is equal
to the CAI of the returns on the best alternative investment? Because during the following
period, that is after 56 years, the owner can obtain more interest from an alternative
investment, such as a savings account. How many percent the value of the CAI is of total
value of the stand is indicated in column 6 of Table 8-1. This is referred to as the rate of return
on investment, that is ROI, the increment of the value of the stand if the stand is left to grow
59
for another period. With 3 percent market interest rate, the owner should cut the stand at the
age of 56 years, because in the next year (if you refer to the data) the stand yields a lower rate
of return than the best alternative investment. Meaning, at the age of 56 years the value
growth of the stand is equal to the interest rate. Another way to reach the same solution would
be to calculate the present value of the net benefits from selling the stand. Using the same 3
percent interest rate (referring to the data) the computation produces the solution, 56 years.
Furthermore, since the economic solution takes into account the cost of time (discounting), we
can assume that the optimal economic rotation (period) to be shorter than the optimal period
when the MAI is maximized. Referring to our illustration, maximizing the MAI occurs at the
age of 60 years, while the economic solution occurs at only 56 years.
An increase in the interest rate shortens the optimal rotation period. In fact, the relative
growth rate decreases with age. Hence, the alternative investment becomes profitable earlier
with a higher interest rate. Looking at our data, this can be illustrated by taking 5% the
interest rate, it will be optimal to harvest the stand before it is 50 years of age, because ROI is
5 percent somewhere between forty and fifty. So far, we have solved an economically optimal
rotation problem, although it is not the Fautsman solution. The Fautsman solution takes
replantation after the first harvest into account.
8.6 RENEWABLE NATURAL RESOURCES: CHALLENGE TO LDCS
The primary issue is whether there is adequate natural resource base in developing countries.
Non sustainable rates of exploitation of renewable resource systems such as forestry, fisheries,
agriculture and water systems have taken place in these countries. In the long run, there will
be greater dependence on renewable resources. The challenge is how to avoid the irreversible
changes in renewable resources. These irreversible changes in renewable resources use pose
difficulty for the policy makers. Will it be wise to build a reservoir with a short term output
(use) of water, power, flood control, and fisheries, knowing that the valley taken out of
production could never be returned to other uses? Should the original forests be cleared of
their timber, knowing that the natural forests can never be re-grown? Should mono-cultures of
specialized crop varieties be promoted, knowing that many local varieties that have been
adaptive to the particular locality will be lost and not available for future adaptive breeding?
60
The long term process of avoiding irreversibility should start with wise investment and
learning to manage the system more productively. For instance, in fisheries the process -
avoidance of irreversibilites - involves maintenance of viable fish stocks through control of
fishing effort and the protection of water quality from toxic materials that endanger fisheries.
Many of the most valuable and unique fisheries (lobsters, prawns, shrimps) have been lost to
massive amounts of degradable and easily treated organic wastes. In forestry, the rapid
progress of deforestation is causing worldwide concern with regard to tropical zones.
Highland rainforests that are crucial as watersheds and to the conservation and regeneration of
soil are being cleared at alarming rate (non selectively). The three great regions of tropical
rainforest, the Amazon, West and Central Africa and Southeast Asia and experiencing
deforestation. The present trend indicates the practical elimination of the tropical rainforest.
In agriculture, the process of avoidance of irreversible changes involves the conservation of

erodible soils, the use of proper drainage in irrigated areas, the elimination of chemical build-
ups in soils and water bodies and limitations on the introduction of mono-cultures. In the
water sector, water sources must be protected to maintain both their quantity and quality.
Water resources are directly related to other sectors of the economy, including other
renewable resource sectors. Forests provide natural watersheds. Agriculture consumes
massive quantities of water. Land uses of all types contribute to erosion. The process required
to avoid irreversible changes have large costs associated with them.
That is, lower fish catches, less opportunities to get foreign exchange or scarce technology.
For LDCs, the trade-off current benefits for long-term sustainability of the resources is a hard
choice that requires rational decision about further development or depletion of these
resources.
The less developing countries face quite different situations regarding their renewable natural
resources than the countries that developed during the 19th century. Now these countries have
available technologies and international markets that make huge exploitation of renewable
resources possible and attractive. Furthermore, population densities and limited farming areas
encourage rapid depletion of the renewable natural resources. The causes of renewable
61
resource problems include, in addition to population pressure, technological change and the
pace of economic growth that stimulates technological change.

1. Explain the concept of renewability.
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
2. Discuss the optimal rotation model.
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
8.7 SUMMARY
In dealing with the concept of renewability, the central issue is the renewable resources
distinctive characteristic which make them capable of natural regeneration. Maximum
sustainable yield could be maintained by controlling the fishing effort. Complications to the
analysis of fishery resources arise due to common property rights complex marine
environment and data problems. The biological model explains the possibilities of harvesting
fish on a sustainable basis. Keeping up a larger population of fish stock would have an
existence value, such as observational and photographic. Open access fishing results in
overexplotation of the fish stock. In such cases, protection of fish stock reproductivity could
be achieved by fishery regulation methods, such as closed season and aggregate catch quota.

62
UNIT 9: ENVIRONMENT AND DEVELOPMENT
Contents
9.1 Introduction
9.2 The Environment
9.3 Common Development Issues and Environmental Links
9.4 Population Growth and The Environment
9.5 Economic Growth and The Environment
9.6 Valuing The Environment
9.6.1 Benefit-Cost Analysis
9.6.2 Indirect Method
9.7 The Theory of Externalities
9.8 Economic Theory of Pollution and Control
9.8.1 Pollution Abatement
9.8.1.1 Tax-Subsidy
9.8.1.2 Regulatory Approach
9.8.1.3 Pollution Certificates
9.9 Summary
The aims and objectives of this unit is to introduce to the students the environment and its
quality resources. It indicates about the link between economic growth and the environment,
population growth and the environment. It introduces to the students the theory of
externalities and the economic theory of pollution and control.

- to understand the environment and the environmental quality resources
- to understand common development issues and environmental links
63
- to understand economic growth and the environment and population growth and the
environment
- to understand how the environment is valued
- to understand the theory of externalities.
9.1 INTRODUCTION
The interdependence of economic development and environmental system and population

growth and the environment are separately discussed in this unit. The common development
issues and the environmental links are explored. The central issues to be raised in valuing the
environment are discussed. The concept of externalities as a central issue deals with the
economic effect of resources along with materials balance. The major issue is dealing with
economic theory of pollution and control is how to place money values on environmental
goods is dealt with in this unit. Approaches to pollution abasement are discussed in this unit.
9.2 THE ENVIRONMENT
The environment provides the economy with the raw materials which are transformed into
consumer product by the production process. It also provides energy which fuels the
transformation. However, these raw materials and energy return to the environment as waste
products. Environmental quality resources are dynamic in nature varying in response to
changes in human values, aspirations and lifestyles. Technology and economic conditions
have great impact on the environment, as a negative effects of industrialization: humans
divorcing from nature, the disruption of the life support systems and the breakdown of the
traditional social structures. Hence, environmental values have changed due to fluctuations in
the world business cycle. Thinking about sustained growth, the effects of new technologies
and the pace of industrial expansion brought greater awareness of the costs involved.
Furthermore, with increased affluence people were able to appreciate non-materialist values
(environmental values).
The importance of nature preservation, landscapes, river and air quality is not equally
appreciated by all societies. There will not be a consensus valuation of specific environmental
components, what may be a resource of great intrinsic value to an individual can be irrelevant
64
to others. For instance, a waterlogged marshy ground may be regarded as a necessary nature
conservation area by the ecologist or wild life (bird) protector, but will be regarded as waste
land which lowers agricultural productivity by the farmer. These differences in evaluation are
the root cause of the conflicts over the use and allocation of environmental resources.
9.3 COMMON DEVELOPMENT ISSUES AND ENVIRONMENTAL LINKS
Increased prosperity as a major concern in the society should deal with the resource concern
focused on the physical environment, its limits and deteriorating quality. The basic resource
problem were defined in physical terms and their scarcity.
- the exhaustion of essential metallic and energy minerals.
- the danger that pollution would disrupt the global biodiversity balance
- the depletion of renewable resources, such as aquifer water, soils, forests and fish
- the loss and scarcity of those environmental quality resources which are of
recreational and amenity and athletic value to the population.
Population Growth
One of the primary objectives of LDC population control programms is to increase living
standards. With increased prosperity people may demand goods and services which place
more strain on natural systems. However, even a declining population will not prevent
depletion scarcity and environmental degradation if those remaining pursue an increase in
material prosperity (Western Europe).
Population growth rates are higher in low-income countries. Larger population increase the
degree of poverty by reducing income and by spreading the family resources to a larger
group. It also puts a great pressure on the natural resource base. People will move to marginal
lands and the carrying capacity will be affected.
Land Ownership Pattern

There is a high degree of inequality in land ownership. Pattern of high concentration of land
ownership among few wealthy owners is common. This puts pressure on the land with
negative consequence. Agricultural economics advocates access to land as prerequisite to
increased output.
65
Trade Policies
The terms of trade for LDCs has deteriorated in the recent past. The impact is that LDCs have
lesser international purchasing power. That is LDC would be able to purchase fewer imports.
Increased import substitution in the industrialized world would lower demand for LDC
exports. Such kind of policy to reduce natural markets for LDCs would increae poverty and
would have a degrading effect on the environment. The Multi-Fiber Arrangement is a case in
point (1974). This was an arrangement by the developed countries to substantially reduce
LDCs exports of textiles which are produced by labour-intensive methods. Subsequently,
some LDCs had to substitute resource - intensive economic activities, such as timber exports,
for more environmentally friendly fiber based production to earn foreign exchange.
Agricultural trade flows which is in favor of the industrialized countries, is supported by
price, distortions which resulted in excessive agricultural production developed countries and
too little LDCs. The resulting unsustainable development in these low income countries
would increase poverty.
Debt
The LDCs have immense level of debt to service ($1290 billion. World Bank 1989) which
results in negative net outflow after interest and principal payment. The other evil is capital
flying out of the capital hungry LDCs where it is much more needed. This large stock of flight
capital held abroad by the citizens of LDCs. This condition would encourage low-income
countries to overexploit their resources in order to get the necessary foreign exchange.
9.4 POPULATION GROWTH AND THE ENVIRONMENT
Thomas Malthus came out with a view that population growth (urge to reproduce) would
outstrip the growth of food supply. Resulting in starvation and death. Ecologists suggest that
the environment possesses a carrying capacity to support humans (biological life), exceed that
capacity, ecological disruption (disaster) would occur.
One of the interesting topic for class discussion will be: what is the relationship between
humanity and the environment? How is this relationship affected by human economic
activity? As sources of concern we consider the following points:
66
- world has lost 1/5 of the topsoil from its cropland or arable land
- world has lost 1/5 of its tropical rainforest
- world has lost immense amount of plant and animal species
- human activities increased carbon dioxide level
- dead forests and lakes are common sights everywhere
Pimentel (1994) has suggested that the optimum global population, defined as the largest
population that could be supported sustainably (in relative prosperity) is about two billion
people. On the other hand, developing countries' growth in population is desirable. Growth in
population in LDCs (cultures) is considered as an insurance against old age.
The economic perspective of the consequences of population growth:

- rapid population growth puts more pressure on both depletable and renewable
resources
- negative environmental effects of population density coupled with poverty
o forestlands are declining in Africa, as trees are cut down to provide fuel for
cooking for the expanding population (firewood)
o in poorer areas, LDCs farmers are forced to farm marginal lands, which would
rapidly be exposed to erosion
o in countries with high population growth poor farmers are the major sources of
environmental problems. How?
9.5 ECONOMIC GROWTH AND THE ENVIRONMENT
Growth and new investment stimulate technological change. This produces new market
opportunities which is part of the growth process. The size of modern industrial output, the
rapid technological development, the continued pressure for more material growth have
increased the rate of environmental change. For instance, the use of fertilizers and pesticide
and the cultivation of marginal lands have affected landscape quality and reduced the
diversity of flora and fauna. In some cases they have also destroyed the natural structure of
the soil and caused soil erosion (Green, 1981). These changes in rural environment happened
because of the pressure to intensify agricultural production in LDCs where food shortage is
chronic.
67
The pace of economic growth and its measurement in materialistic terms is identified to be the
popular cause of the environmental problems. Some of the solutions advocated by
environmentalists include among others, is the stop growth or redefine it to include 'quality of
life' variables approach.
Growth as a cause to environmental problems:

It was argued that economic growth is incompatible with the closed and limited physical
system of the earth. Furthermore, it was emphasized that politicians and economists are
preoccupied by short-run economic growth. This helps distort the whole production process
towards maximizing the net present value of physical output as defined by the current tastes
and income levels, to the detriment of spatial and temporal distributive equity. Not only are
the requirements of the future generations ignored, but present day consumers are denied non-
marketable quality-of-life goods and services. In the long run, the proponents argued, that the
continued pursuit of material growth will reduce real social welfare.
On the other hand, implication of no growth has no practical relevance. Even if economic
growth implies increasing consumption and therefore, greater demands on the earth's resource
base and its life support system, some growth would have to occur to allow those living at
bare subsistence levels to continue to live at all. No growth would consign millions of people
to levels of material existence which are not acceptable. Moreover, this can do nothing to
solve the problems which already exist when present use intensities exceed the natural
regenerative capacity of the environment.
Even with some sort of growth, due technological progress (green revolution), there is still
widespread existence of malnutrition and starvation. Semi-arid and arid environment
succumbed to drought, became drought prone places when they came under pressure to
increased pastoral and arable production. So agriculture is pushed into marginal areas, the
resulting destruction of vegetation and soil would reduce potential productivity.
For the economically developed nations, the Four-Hundred-Year Boom has brought greater
economic benefits and freedom at a great cost. The cost of economic growth are quite many.
The capacity of the environment to absorb industrial wastes has been reduced. The pollution
68
of land, air and water has increased tremendously. Advanced methods of agricultural
production have enhanced the loss of topsoil due to erosion.
The majority of the world's population have only slightly benefited from the Four-Hundred-
Year Boom. Deforestation along with the resulting fuel shortage, scarcity of water and the
deterioration of water and air quality resources have greatly exacerbated the situation of the
majority of the world's inhabitants. Despite advances in technology, increasing resource
scarcity and the loss of environmental quality resources reduce the quality of life. What are
the quality-of-life goods and services? These are non-marketable services, such as unpaid
housework, voluntary services and home-produced vegetables. In the face of an uncertain
future, increasing scarcity and higher prices of resources may encourage conservation and
thus regulate supply.
9.6 VALUING THE ENVIRONMENT
One of the fundamental issues in the field of environmental economics is the evaluation of
environmental resources. This valuation uses the cost-benefit analysis framework of
environmental projects. The other approach is to assess the damages done to natural
resources. These environmental resources include air, surface and ground water, forestland,
and natural landscapes. Shechter asserted that these environmental assets or resources do
provide three functions:
- ecological system support
- negative inputs (industrial waste sinks) in production process
- amenities that are consumed by individuals (clean air and water for household use)
These environmental functions are not free and the assets providing these function are
considered to be economic goods and services but not the conventional economic goods. The
special character of these goods and services is that they do not have market-determined
valuations, that is they do not have price tag. There is no market transaction for these goods.
Hence, these environmental goods become non-market goods. They are also known as public
goods in economic theory.
69
Theoretical grounds for non-market goods:
In valuing environmental goods, there is the implying assumptions that the necessary
information or data with regard to the impact of environmental goods, be it negative
(pollution) or positive (outdoor recreation) is available.
In the absence of markets, how would the public body decide about the optimal level of
provision, maintenance and conservation of environmental assets or services ? Economists
suggest Benefit-Cost analysis, a decision-support technique that could offer good guidance to
policy-makers.
9.6.1 Benefit Cost Analysis

Benefit cost analysis is used not only to compare the benefits and costs of individual projects,
but also identify the resource allocation project with the highest positive net benefit, among
competing alternatives. For instance, in a project study to improve the quality of an
environmental asset it is worth undertaking if welfare gains exceed costs. The benefits derived
from pollution control are the damages prevented.
Benefits measuring problems:

The environment resource that is not handled through the normal markets, provides the
analyst with two types of benefits:
- use value which is associated with active use, both consumptive and non consumptive
(logging of forests or use of water for drinking, and recreational activities)
- non-use value which is associated with passive use, arises when individuals get
satisfaction from the environmental amenities mere existence (improved recreational
opportunities better water quality - concern about a loss of unique environmental
resource)
Non-use value in economic analysis is the major component of total economic value,
which is defined as the sum of non-use value and use value. Thus, non-use value in
damage assessment reflects the proper price indicator for resource use.
Cost estimates:
Benefit Cost Analysis (BCA) is forward looking and it requires estimates of what a project
will cost. Good environmental analysis suggests that environmental protection is good
70
economics. Generally speaking, the use of monetary measures makes comparisons possible
with other monetary benefits and costs from alternative uses of public funds.
9.6.2 Indirect Method

Some of the indirect methods of valuing environmental assets will be reviewed in this sub-
section. The indirect approach is used by environmental economists to place a price tag on
damages caused by environmental degradation or value the benefits from an increased level of
an environmental resource.
Travel Cost Method

The travel cost method (TCM) is the evaluation method used in studying environmental
amenities and recreational services. Using this method the analyst should estimate the
magnitude of demand for natural resources, such as national parks and nature reserves, and
put value on the inputs used in producing outdoor recreation activities. Hiking, camping,
fishing, boating, swimming and wildlife observation are some of the outdoor activities which
are considered to be economic services produced by the natural resource. The basic
characteristic of these services is that they are produced and consumed in situ. The user must
travel to the place of consumption of these services. The TCM provides the basis for the
computation of the value of time spent or the cost of travel to the recreation sites, entrance
and other site fees which constitute the economic value. Thus, the TCM was initially used to
place a value on a natural recreation site whose services (recreational) have been provided
free of charge. Moreover, TCM was employed to give value to these recreational services of a
BCA of water resource projects.
Hedonic Price Model

The Hedonic price model (HPM) has been used to give monetary value to environmental
benefits indirectly through the impact of these environmental service on prices of related
market goods and services. The most common application of HPM is to do with the valuation
of the impact of polluted air on residential housing locations. The basic concept of HPM is
that the price of related market good, like the price of a house which is made up of many
components: physical attributes as well as environmental services like area air quality, noise
level, proximity to open space.
71
Thus, the HPM provides a basis for evaluating environmental services through consumers
actual purchasing habit in the housing market. This method provides the expression for air
quality, for instance, the consumers would be willing to pay more for a house in an area with
better air quality, compared with a house in a polluted area.
9.7 THE THEORY OF EXTERNALITIES
The concept of externalities is the central issue when dealing with the economic effect of
renewable resource depletion and degradation. Externalities or external costs and benefits are
the unaccounted (uncompensated) side effects of any economic or social activity, which are
not taken into consideration when individuals make private decisions. The term
uncompensated indicates the exclusion of all the external costs and benefits in normal market
transactions. Externalities occur in extra-market situations when the by-products of any
activity result in costs or benefits to other people, which is not compensated or given market
value. In the renewable resource sectors externalities are an inevitable consequence of the
way our economic system deals with the cycle of production, consumption and disposal of
goods. Only those resource supplies which are directly used in production and consumption
are priced and incorporated into the market. Within a social system externalities are common
feature of everyday life, such as smoking in public places, talking in libraries or using a
running water as a waste disposal system; are cases where external costs are incurred.
Numerous cases of externalities are considered too minor or expensive to be corrected and left
unabated. Zooing of buildings and trains into smoking and non-smoking areas are just few of
the measures taken to correct the cases of externalities.
The flow of unwanted products back to the environment was systematically ignored. No value
was placed on the limited capacity of the environment to absorb and assimilate waste.
Recognized by Boulding (1966), consumption is not the final act of the economic system.
Waste disposal is. According to the law of thermodynamics matter is neither created not
destroyed, it merely changes form with use. Thus, in the process of material production and
consumption, matter is returned to the environment as indicated in Figure 9.1.
72
Figure 9.1 Materials Balance
PRODUCTION CONSUMPTION
Discarded Goods
ENVIRONMENT
ASSIMILATES WASTE
RESOURCE
SUPPLIES
Production flows
Residual flows to the environment
Source: Adapted from Rees, 1997
In the case of transfer externalities, the costs are imposed by one economic unit on other users
of the same resource. This happens when firms or households discharge waste products into
the environment. For instance, a manufacturing company uses a watercourse for effluent
(waste) disposal. Here, the private costs of waste removal are insignificant. But the external
costs could be of higher magnitude or proportions. These include loss of fish yield, increased
water treatment costs, declining recreational value of the stream and the losses involved from
irrigation use and domestic supplies.
These costs are not considered when the manufacturer selects a location, output levels,
production techniques or the type of raw materials to be used. Consequently, few productive
resources are appropriated to waste disposal, limited research to improving waste reduction or
removal methods and too much waste is produced with alarming rate of damage it causes.
When waste disposal (pollution) occurs to the air, some of the damage costs will be
transferred to downwind locations, as the acid rain problems of Scandinavia and Canada
demonstrated. But, there are conditions, in which dispersal is limited, and the greater part of
73
the damage falls on the polluters. For instance, all car owners within urban areas share the
damage costs they create.
9.8 ECONOMIC THEORY OF POLLUTION AND CONTROL
Placing money values on non-market goods is very difficult and some approaches have been
suggested to measure gains and losses of these goods with no established market price. This
applies to the whole range of environmental goods and services, such as landscape amenity,
clear air and water supplies. One of them is the physical damage cost estimation approach.
The notion of valuing pollution by calculating the physical damage costs is easy to understand
conceptually, but difficult to put it into practice.
Various studies have tried to place money values on the material damage imposed by air
pollution causing corrosion, and soiling of buildings, paintwork and household fabrics. The
approach suffers from a problem inherent in all cross-sectional studies, of isolating the effects
of pollution from other variables, such as variation in rainfall, sunshine exposure …).
In fact, agricultural productivity can be reduced by air pollution, yields of commercial crops
can fall or be delayed due to the presence of SO 2 (Sulphur Dioxide). The damage cost
estimation work has also focused on health, covering the increased expenditure on health care.
Although it has been recognized that air, water and land pollution (toxic substance in soils)
have a detrimental effect on health, the cause-effect relationships remains undiscovered. Table
9.1 Provide some examples of losses in damage category.
Table 9.1 Pollution Damage Costs

Damage Category
Human health Fauna Flora Natural Materials Climate and
resources weather
Financia Productivity losses, health cost Reduced Lost Reduced Shift in world
l Loss care costs including animal crop production life of a rainfall
increased costs to reduce and production, from material, pattern.
pollution fish species forest polluted increased (agricultural
growth water and repair costs loss)
reduction soil,
74
increased
treatment
cost
Loss of Cost of suffering, cost of Reduced Reduced Decreased Damage to Decreased
amenity limitations pleasure pleasure recreation aesthetic pleasure from
from from benefits monuments reduced
fishing and landscapes and objects visibility
wildlife and floral
observation species
observation
Source: Based on OECD, 1976

9.8.1 Pollution Abatement
According to Randall, economic theory offers certain specific approaches to the problem of
air pollution due to the residuals from production or consumption activities. What are these
approaches? One of the approaches is the tax-subsidy approach which tries to deal with the
manipulation of the price in maintaining or restoring efficiency. Regulatory approach deals
with the quantity of the residuals released. The other solution is the pollution certificate
solution. In this program government authority is used to establish the total quantity of
residuals, and use market forces to allocate production among potential polluters. In all these
approaches government plays a key role.
9.8.1.1 Tax-Subsidy
In the tax or subsidy approach, government establishes the price of residual (as developed by
the economist pigon). A negative price would be placed on the residuals by a public agency.
This would be accomplished in either of two ways.
- Taxes would be levied on the polluter (acting party) in direct proportion to the
residuals released.
- Baseline level of emissions could be established, and the agency could subsidize the
polluter for reductions in residuals.
A case of pollution tax is illustrated.
75
Figure 9.1 The Pigovian Tax Solution
D S
Demand, Supply and
tax
Tax/emissions
O Q1 Q0
Abatement
A straight line tax is levied on polluting emission. Meaning, the same tax is levied on each
unit of emissions regardless of the level of total emissions. The equilibrium quantity of
emissions is determined by the intersection of the tax line and the supply curve for the
abatement.
A public agency, economic efficiency as its objective will attempt to set the tax so that the tax
line passes through the intersection of the supply and the demand curve.
The equilibrium level of abatement is Q 1, the total tax equal to the total tax rate times Q 0 - Q1
is to be collected. This Pigovian tax solution uses the public agency's power to place a
negative price for a discommodity.
Each polluting firm or consumer is free to determine the best method of minimizing cost
imposed. That is, each one would implement the least-cost method of pollution abatement. It
should determine how much abatement to provide subject to the constraint that tax to be paid
for unabated pollution. The taxes provide a incentive for improved abatement action, by
implement cost-reducing abatement technology.
76
In reality, variants of tax-subsidy idea have been implemented rather than the straightforward
Pigovian tax solution. Some could be less efficient, such as those policies that subsidize the
use of particular pollution control device directly or through special tax deductions. Why? By
identifying specific pollution - abatement inputs (devices) for favorable tax-subsidy treatment,
the market distortion in abatement inputs sets in. Others are discouraged.
9.8.1.2 Regulatory Approach

Regulatory approach is another method of regulating directly the quantity of pollution that is
allowed. A government agency would determine the maximum allowable amount of pollution
for every polluting firm and consumer. Considering air pollution, the kind of regulation
imposed is known as an emissions standard. For water pollution, it is known as effluent
standard.
Figure 9.2 An Emissions Standard
S
Standard
Penalty
penalty/excess
Supply and
missions
O Q1 Q Q0
Abatement
The standard is represented by a vertical inc. It indicates that Q S level of abatement must be
provided, or there will be violation by the polluter.
A straight line fine per unit of excess emissions is assumed. This is analytically interesting.
The polluter will abate to the point (Q 1), at which the expected penalty line intersects the
77
supply curve for abatement (polluters supply curve), if Q 1 lies to the left of the standard - but
will comply with the standard if the intersection lies to the right of the standard.
The polluter provides abatement to Q 1, pays expected penalties which is equal to expected per
unit penalty times QS - Q1. the expected penalty line intersects the supply curve for abatement
at a point left of the standard. The equilibrium (output) point, there is some abatement,
payment of some penalties for emissions.
Is there any assurance that polluters will comply with the standard? There should be some
penalty for failing to comply, otherwise compliance will not be achieved. In setting of penalty,
it should be made high enough and should be well enforced so that polluters will agree to
comply with the standard. In real world, some pollution-control devices are used to regulate
partial emissions.
9.8.1.3 Pollution Certificates

Another approach to offering incentives for pollution abatement is pollution certificate. The
pollution control public agency would decide the total allowable emissions of a specific
pollutant in a geographic location (area). Supposing the public agency used are efficiency
criteria with sufficient information at its disposal, with respect to air and water pollution (and
basic environmental processes), it would allow total emissions of Qe = Q0 - Qa, as indicated in
78
Figure 9.3 A pollution Certificate Schedule
D
S
Abatement
Price of
O Qa Q0
Abatement
Figure 9.7 represents a determination of the total number of the total number of certificates to
print. D and S represent the total industry demand and supply of abatement.
Consider air pollution. The total allowable emissions would be determined after the supply
curve for abatement (reductions in emissions), the demand for good-air quality, and the
physical relationship between emissions and good-air quality are taken into consideration.
The economic incentive to this programme is that it allows to allocate emission certificate,
that is, the right to pollute, to the highest-cost abaters and also generate income for the public
like emissions tax.

1. What are the basic resource problems?
___________________________________________________________________________
___________________________________________________________________________
2. Describe the methods of valuing the environment.
___________________________________________________________________________
___________________________________________________________________________
79
9.9 SUMMARY
The resource concern now is focused on the physical environment, its limits and deteriorating
quality. The common development issues in relation to environmental links are population
growth, land ownership pattern, trade policies and debt. Hence, the economic consequence of
population growth has a wider implication in putting more pressure on renewable and non-
renewable resources. The cost of economic growth is quite high when considering the
pollution of land, air and water. Increasing resource scarcity and deterioration of the
environmental quality resources put quality of life at risk. One of the methods of valuation of
the environment is the cost benefit analysis within a framework of environmental projects.
Other approach would concentrate on assessing the damages done to natural resources. Some
of the indirect approach of valuing the environment are the Travel Cost Method (TCM) and
the Hedonic Price Model (HPM). Externalities are external costs and benefits that are the
uncompensated side effects of economic or social activity. Pollution abatement policies
include the tax-subsidy, regulatory approach and pollution certificates.

80
UNIT 10: SUSTAINABLE RESOURCE MANAGEMENT
Contents
10.1 Introduction
10.2 Sustainability Concept
10.3 Sustainability Management
10.4 Summary
The aims and objectives of this unit is to introduce to students to sustainable resource
management and the concept of sustainability.
What you will learn in this unit:

- to describe the sustainability concept
- to understand the sustainability resource management
- to define sustainability
10.1 INTRODUCTION
The sustainability concept is defined in this unit. The sustainability resource management
notion is discussed and a typical example is offered in relation to forestry management.
10.2 SUSTAINABLITY CONCEPT
The definition of sustainability suggests that the non-renewable resources should no longer be
used at all because they are not renewable. Only this way could they be preserved on a
sustainable basis. If the concept of sustainability is so narrowly restricted, however, we are in
a logical dilemma. Why should the resource be preserved when they are not used? In fact, if
we no longer use the resources we would already have reached the point of depletion - the
point which otherwise we would reach when all stocks have been depleted.
81
To avoid this dilemma, it is often demanded that use of non-renewable resources may
continue for the time being, but if only they are gradually replaced by renewable resources.
According to this concept, the use of renewable resources were to increase at the same extent
as stocks of non-renewable resources decline. In the end, when all non-renewable resources
have been consumed, we would have to do with renewable resources. But, this solution would
only be satisfactory if the renewable resources continue to be used in a sustainable way. Given
the present structure of production and consumption, this is difficult (impossible) because the
magnitude in which renewable resources would have to be harvested is very high.
10.3 SUSTAINABILITY MANAGEMENT
Sustainable forestry management, for instance, states that timber cuts should not exceed
incremental forest growth, that is, the forest is neither over-used nor destroyed. This concept
applies to all renewable resources. For instance, at the beginning of industrial revolution,
timber as a renewable resource could only be saved from extinction, that is, sustainable use of
timber, at that time most important renewable resource, by replacing charcoal with the non-
renewable hard and brown coal. Otherwise, forests in Europe would have been totally cleared
or depleted.
Although the use of renewable resources can be intensified to a certain extent, as can be seen
from modern agriculture, resource management should consider waiting for the resources to
regenerate. Furthermore, renewable resources require large areas of land to enable the
functioning of the biological and ecological cycles within which their renewal takes place.
Given the various services the land is required to give, it is the scarcest of all resources.
Thus, re-substitution of non-renewable resources would quickly result in their over-use, that
is, extraction would exceed annual increments. It is claimed that using isolation to generate
energy and substituting the non-renewable energy sources with solar energy might open a way
out of the dilemma. The options discussed are the direct use of solar energy, for instance, the
generation of thermal energy by solar collectors and the generation of electrical energy by
photo-voltaic, as well as indirect use, example, by burning biomass-timber, agricultural
82
residue, biogas, energy crops like beet, rape- and production of electrical energy from wind
and hydropower.
However, this has got its own drawback. It ignores the ecological damage that can result from
using solar or renewable energy. Although global insolation is very high, it is so diffuse and
discontinuous that large areas are required to collect and store this energy as well as to
transport it from the point of collection to the urban areas where the energy is needed. Unless
dual use of land is not made possible, this additional land consumption causes additional
sterilization of land. Besides, loss in environment and habitat for plants, animals and humans
could occur.
The construction of windmill parks and photovoltaic plants outside of residential areas results
in the large-scale destruction of landscapes. And growing so called renewable crops increases
soil pollution due to the increasing use of fertilizers and pesticides. Therefore, the use of solar
energy should be restricted if the destruction of the environment and habitat is to be avoided.
Mention should be made to the fact that the construction of small hydropower plants
endangers fish stocks.
A way of the sustainability dilemma may only be found if we decide to define a pattern of
sustainable use specifically for non-renewable resources and to make this part of the whole
sustainability concept. This is possible when we adopt sustainable development as an
important option to sustainability. Thus, the following proposal is suggested: non-renewable
resources are used sustainably if they extraction is continuously reduced to the extent that
they are never fully depleted.
Consider fossil energy sources: the extent to which extraction must be reduced depends on the
size of the stocks as compared to current production rate (among all others). This means that
we should first have all estimation of the size of fossil energy resource stocks that can
probably be extracted (inferred resources).
What is the concept of sustainable development? The Brundtland Report (our Common
Future, 1987) produced by World Commission on Environment and Development, had
advanced the concept of sustainable development. According to the report, environment and
development are not separate challenges, they are interlinked. Development cannot be
83
sustained on a deteriorating environmental base. The report defined sustainable development
as development that seeks to meet the needs and aspirations of the present without
compromising the ability to meet those of the future. Furthermore, it was stated that
sustainable development recognizes that the problems of poverty and underdevelopment
cannot be solved unless a new period of growth in which developing countries play a larger
role and reap greater benefits occurs. Meaning, growth must be revived in developing
countries because that is where the links between economic growth, the alleviation of poverty,
and environmental interaction takes place. In light of this recognition of the economy -
environmental interdependence and the current level of resource consumption,
environmentalists have expressed their concern about the limit of the environment. Some
authorities or optimists suggested that, by adopting policy which could be applied on world-
wide level, it would be possible to make growth sustainable. Those policies should aim to
reduce at a global level, the rate of resource consumption or the material content of the
economic activities.

1. Describe the sustainability concept.
___________________________________________________________________________
___________________________________________________________________________
2. Explain sustainable forestry management.
___________________________________________________________________________
___________________________________________________________________________
10.4 SUMMARY
sustainability is defined as a system of management in which the non-renewable resources

should not be used at all because they are not renewable. Sustainable management of
resources suggests that renewable resources should never be over-used or destroyed. Besides,
resources management should consider giving ample time for the resources to regenerate.
1. Refer to section 10.2 2. Refer to section 10.3
84
REFERENCES
 Folueretal. 1997, Principles of Environmental & Resource Economics
 Howe, Charles. 1982. Managing Renewable Natural Resources in Developing
Countries
 Perman etal. 2003. Natural Resource & Environmental Economics
 Randall, Alan. 1987. Resource Economics. An Economic Approach to Natural
Resources and Environmental Policy.
85

Natural Resource and Enviromental Economics

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Natural Resource and Enviromental Economics

Uploaded by

Copyright:

Available Formats

UNIT 1: NATURAL RESOURCES

1.0 AIMS AND OBJECTIVES

What you will learn in this unit

What constitutes natural resources have changed over time in response to

1.2 DYNAMISM IN NATURAL RESOURCES DEFINITION (MINERALS)

1.2.1 Resource/Reserve Classification

Original Resource - The amount of a resource before production.

Demonstrated - A term for the sum of measured plus indicated.

ECONOMIC Reserves Inferred Reserves

Other Occurrences Include Non-conventional & low grade materials

1.2.2 Stock Resources and Flow Resources

Exhibit 2: Resource Classification

Consumed Theoretically Recyclable Critical Zone Non Critical

Oil All Metallic Fish Solar energy

Flow resources used Critical zone resources become stock

2. Describe the principles of a resource classification.

1.4 ANSWER TO CHECK YOUR PROGRESS EXERCISE

1. Refer to sub section 1.2.2

2.0 AIMS AND OBJECTIVES

What you will learn in this unit

Proven reserve levels depend on the following variables:

2.3 CONDITIONAL RESERVES

The onset of economic exhaustion

MC - MCn MC/supply curves at different point in time

Check Your Progress Exercise

2.6 ANSWER TO CHECK YOUR PROGRESS EXERCISE

1. Refer to sub section 2.2

3.0 AIMS AND OBJECTIVES

What you will learn in this unit

3.2 FEARS OF SCARCITY

The Poralyzed Scarcity Debate

3.3 ABSOLUTE PHYSICAL EXHAUSTION AND TECHNOLOGICAL INNOVATION

Figure 3.1 The market response to resource scarcity.

Extraction cost rise

Demand decrease Supply increase

Increase use of Increase use of

Development of new Search for now

The Market Response Model

3.6 ANSWER TO CHECK YOUR PROGRESS EXERCISE

1. Refer to sub section 3.2

4.0 AIMS AND OBJECTIVES

What you will learn in this unit is

4.2 ATTRIBUTES OF RESOURCE MANAGEMENT

4.3 INTERVENTIONIST MEASURES

4.3.1 Trade Regulation

Trade Promotion Measures

Capital Value Tax

4.3.3 Price Regulation

4.3.3.1 Regulation of Domestic Energy Prices

Check Your Progress Exercise

It is indicated that government intervention in the production of minerals has wider

4.5 ANSWER TO CHECK YOUR PROGRESS EXERCISE

1. Refer to section 4.3

5.0 AIMS AND OBJECTIVES

What you will learn in this unit

5.2 ECONOMIC EFFICIENCY

Thus, the production functions are:

5.3 EFFICIENCY IN PRODUCTION

5.4 EFFICIENCY IN CONSUMPTION

Furthermore, consumer choice is constrained by what is made available, known as availability

Point d defines a production mix.

5.5 ALLOCATIVE EFFICIENCY AND THE PARETO EFFICIENCY CRITERIA

Necessary conditions for Pareto-Efficiency

Efficient Resource Allocation: