ECON 317: NATURAL RESOURCE

ECONOMICS
INSTRUCTOR: C. PINDIRIRI
The economics of renewable
resources.
 DEFINITION
 Environmental resources are said to be renewable when
they have a capacity of reproduction and growth.
 They can be classified as:
1. Living organisms e.g. fish, forests, cattle, elephants
2. Inanimate systems e.g. water and atmospheric
systems.
 The first class has capacity for natural growth and the
second class of resources are reproduced through time
by physical processes, e.g. water can self-replenish as
stocks run down.
 Arable and grazing lands are also renewable resources
– reproduction and growth take place by a combination
of biological processes such as recycling of organic
nutrients
 STOCKS AND FLOWS

 The stock is a measure of the quantity of the resource

existing at a point in time, measured either as aggregate
mass of the biological material (biomass) or in terms of
population numbers, e.g. the volume of standing timber.
 Flow is the change in the stock over an interval of time,
where the change results either from biological factors
such as recruitment (the entry of new fish into the
population) or from the exit from the population due to
natural death, or from economic factors such as
harvesting.
 Examples of renewable flow resources include solar,
wave, wind and geothermal energy.
 COMPARING RENEWABLE AND NON-
RENEWABLE RESOURCES
 Both renewable and non-renewable resources are
capable of being fully exhausted (stock driven to zero if
too much harvesting or extraction activity is carried out).
 For non-renewable resources, exhaustibility is a
consequence of the finiteness of the stock.
 Unlike non-renewable, a renewable resource can
potentially be supplied to an economic system
indefinitely.
 It can be however driven to zero if conditions interfere
with the reproductive capability of the renewable
resource, if rates of harvesting continually exceed
natural growth.
 OPEN ACCESS RESOURCES

 Open access resources are resources where private

property rights do not exist.
 In the absence of government regulation or some other
form of collective control over harvesting behaviour, the
resource stocks are subject to open access.
 These resources tend to be over exploited and the
chances of the resource being harvested to the point of
exhaustion is higher than in situations where private
property rights exist and access to harvesting is
restricted.
 In a perfectly competitive industry where property rights
exist and are enforceable, harvesting is socially optimal
 Not the case under monopoly hence the need for some
policy instruments to enforce an optimal harvesting
behaviour.
ECONOMIC QUESTIONS IN THE MANAGEMENT
OF RENEWABLE RESOURCES
 How much of a resource should be harvested?
 Under open access: How much to harvest this season
and how much to leave in the sea/dam/river/bush as a
source for future growth next season?
 Forestry: What is the optimal length of time between
harvests that maximizes the forest owner’s profits?
 Using dynamic optimization, a renewable resource
problem is typically framed as a maximization of some
single measure of net economic value over some future
time horizon, subject to the natural dynamics of the
harvested resource, an initial stock size, a target for the
end of the planning horizon (a limit in the case of infinite
resources), a measure of time preference and other
relevant market, price and technology constraints.
GROWTH FUNCTIONS IN RENEWABLE RESOURCES

 In order to investigate the economics of renewable

resources, we need to assess the patterns of biological
growth of the resource in the absence of human
predators.
 In building a model of a resource, it is necessary to
define a variable(s) which adequately describe the state
of the resource at any point in time.
 We call this the state variable and the “standing stock” in
renewable resources.
 Let us consider the case of a biological resource stock,
whose size at time t is denoted by X t , or in continuous
time, X (t ).
 GROWTH DYNAMICS
 In the absence of harvesting, the dynamics of the
resource stock might be described by the discrete
difference equation;


X t 1  X t  F ( X t ) …………………………….. (2)

 Or by the differential equation;

dX (t )
 X  F ( X (t ))
 dt ……………….. (3)

 These equations of growth assume that the change in

the resource is density-dependent, i.e. is dependent on
the current stock size.
 GROWTH FUNCTIONS
 The growth function in equation 2 or 3 is defined over
the interval X  0, see the diagram.

F(X )

X mvp X max X
 It is assumed that there exist two values X mvp  X max for
which: F ( X )  0 if 0  X  X mvp

F ( X )  0 if X mvp  X  X max
F ( X )  0 if X max  X
 GROWTH FUNCTIONS
 The growth function above is purely compensatory if
 X mvp  0 and F () is strictly concave from below.
F(X )
 The relative growth rate r( X )  is a decreasing
X
function of X .
 If X mvp  0 and F () is initially convex then concave
(has an inflection point), the growth function is said to be
depensatory.
 If X mvp  0 and F () is initially convex then concave as
in the diagram in the preceding slide then the growth
function exhibits critical depensation, and X mvp is known
as the minimum viable population.
 Whether a growth function is purely compensatory or
exhibits depensation is important in understanding the
relationship between yield and effort.
EXPONENTIAL GROWTH OF FISH POPULATION

 Let us suppose that in the absence of any environmental

constraints the fish population has an intrinsic growth
rate denoted by . 
 The intrinsic growth rate is the difference between the
population’s birth rate and its mortality rate.
 If the population stock is X and it grows at fixed rate 
the rate of change of the population over time is given
by; dX
 X  X
dt
 Integrating this equation we obtain an expression for the
stock level at any point in time: X (t )  X 0 et
 For a positive value of , the population of fish grows
exponentially over time and without bounds.
 Growth rate depends on population size, X   ( X ) X
 LOGISTIC GROWTH FUNCTION
 There are several functional forms of growth functions.
 The commonly used function is the logistic which when
written as a differential equation takes the form:
 X (t ) 
X  F ( X (t ))  rX (t ) 1 
 K 
 Where r is called the intrinsic growth rate and K is the
environmental carrying capacity.
 The logistic function is purely compensatory, that is,
X mvp  0 and F () is strictly concave.
o The point X max  K is a globally stable equilibrium, that
is, X (t )  K from any X (t )  0 as t  .
o Solving the above differential equation we obtain:
K K  X (0)
X (t )   rt
where c
1  ce X (0)
 STEADY-STATE HARVESTS

 If the amount of the stock being harvested is equal to

the amount of net natural growth of the resource and the
magnitudes of harvests (H) and natural growth (G)
remain constant and equal over time, then the
harvesting is called a steady-state harvesting.
dX
 Defining  X as the actual rate of change of the
dt
renewable resource stock, that is X  G  H
then it follows that in a steady state X  G  H  0
o We can have a maximum sustainable yield steady-state
harvesting where harvesting at MSY is equal to growth
at MSY.
PRODUCTION AND YIELD FUNCTIONS
 The rate of harvest or yield depends on economic inputs
devoted to harvesting, and of the available stock.
 We refer to the aggregate measure for the various
economic inputs as effort and denote it by E (t ).
 We therefore write the production function as:
H (t )  H ( E (t ), X (t ))
 Where H (t ) is the rate of harvest, measured in same
units as the resource stock X (t ) .
 The commonly used production function is;
H (t )  qE (t ) X (t )
 Where qis a constant. This production function is
based on the following assumptions:
1. Catch per unit of effort is directly proportional to the
density of fish in the sea, and
2. The density of fish is directly proportional to X (t ).
 HARVESTING
 The quantity of fish harvested in a particular period of time is directly
proportional to the level of human effort devoted to the activity (as
measured by some sort of composite index of the number of fishing
boats, the size of fishing crews, types of fishing gear, amount of time
spent at sea, etc.) and the size of the fish stock.
 For simplicity, assume H t  Et where
Xt isEthe
t
level of human
fishing effort in period t.
 For a fixed level of human fishing effort, harvests will be larger when
the fish in the sea are plentiful.
 For a fixed size of the fish stock, harvests will be larger when effort
levels are intense.
 The logistic growth function and harvest functions for three different
levels of effort are graphed in the successive slide.
 The positive slopes of the harvest lines indicate that for a fixed level
of effort, the quantity harvested increases as stock size increases. The
E  line
slope of each harvest E  effort level.
EMSYis the
 In the diagram, .
GROWTH AND HARVEST AS FUNCTIONS OF STOCK

E . X
EMSY . X
F (X )
E . X

0 X X MSY X  K X
HUMAN EFFORT AND CHANGE IN STOCK
 Once we consider the possibility of human harvesting activity, we
can determine whether the stock will grow or decline in size by
noting that the change in stock size between period t and (t+1) is
simply the difference between the amount of net natural growth and
the quantity harvested in period
X X t:  F ( X )  H
t 1 t t t
 If F ( X )  H , the stock will be larger at the beginning of period
t t
(t+1) than it was at the beginning of period t. Just the opposite will
be true if . When H t  F,( X
the
t)
stock size X t )  Ht
F (remains
unchanged between periods t and (t+1).
 In this special case, we say that the stock size is in a steady-state.
 The amount harvested equals the amount of biological growth, so
the stock size remains constant. That is, in period (t+1), if
, then, once again, the stock size will be the same entering period
F ( X t 1 )  H t 1
(t+2) as it was in periods t and (t+1).
 SUSTAINABLE YIELD
 The situation in which
F ( X t )  H t  F ( X t 1)  H t 1    F ( X t   )  H t  
 is called one of sustainable harvest or sustainable yield. In
the diagram, the intersection of the three harvest lines with the
growth curve represents three steady-state, sustainable yield
scenarios. If the stock size is maintained at a level
X MSY labelled as
on the
 horizontal axis, then the amount of one-period biological
growth is maximized.
 That growth, measured in biomass terms, can be harvested on
a sustainable basis, and it is called the maximum sustainable
yield (MSY). X MSY
 If the stock is maintained at the level EMSYlevel of
and the
fishing effort is held constant at , then the harvest will be:
 MSY  EMSY . X MSY  F ( X MSY ) period.
every
 SUSTAINABLE HARVEST

Harvest (H )

0 E  EMSY E Effort (E )
 HARVESTING COSTS
 Let the harvest function be given by:
H  qE. X
H
E
qX
 The total cost of harvesting is a function of effort,
that is:  H 
C  E    
 qX 
 Cost is an increasing function of harvesting rate
and decreasing function of stock level.
 If we consider the equilibrium state where F ( X t )  H t
then the cost of sustainable harvesting is given by:
    X  r  X
C  rX 1    1  
qX   K  q  K
 HARVESTING REVENUE

 Total revenue equals price multiplied by quantity

harvested, that is: TR  p ( H ) * H
 Out interest is in the relationship between total
revenue and the stock of the resources rather than
between total revenue and harvesting.
 The total revenue-stock relationship requires the
knowledge of the relationship between total
revenue and harvesting which depends on the form
taken by the resource demand function.
 A general result is therefore not possible.

 So we assume the revenue-stock relationship to

take an inverted U-shaped form.
 Explain why this is plausible.
 OPEN ACCESS EQUILIBRIUM
 The cost function as a linear function of stock (see previous
slides).

TR, TC 
TC
TC
EQOA

TR

0 X OA X MSY X EE K X

 At open access equilibrium total revenue equals total costs. It is a

steady-sate equilibrium. Explain what happens to the cost function
and equilibrium if in C  E
 changes.
 OPEN ACCESS EQUILIBRIUM
 Consider total cost and total revenue as functions of effort.

TC 
TR, TC

TC

TR

0 EEE EMSY EOA E

 The economic optimal level of effortEEE is less than the
E MSY
MSY effort level which is in turn less than the open
access level ofEeffort,
OA .
EQUILIBRIUM UNDER PRIVATE PROPERTY RIGHTS

 Under open access equilibrium there is zero long run

rent or profit.
 Private owners maximize profits
 The economic optimal levels of stock and effort in the
previous slides are associated with private ownership.
SOCIALLY OPTIMAL/ EFFICIENT FISHERY

 To derive a socially optimal harvesting programme we

maximize a social net benefits function over an infinite
time horizon.
 Net benefits are discounted at a social consumption
discount rate r.
 Socially optimal harvesting programme is identical to a
privately optimal programme if the social discount rate
is equal to the private discount rate.
 This is true only for competitive industries, i.e. property
rights are enforceable and externalities do not exist.
 Externalities are a serious problem for other
renewable resources such as forestry but not a
serious problem in fisheries.
SOCIALLY OPTIMAL HARVESTING OF FISHERIES

 If the social consumption discount rate is r then

the objective is to maximize discounted social net
benefits over an infinite horizon, subject to a
resource growth constraint, that is:

Max   B ( H (t ))  C ( H (t ), X (t )) e  rt dt


dX (t )
subject to  F ( X (t ))  H (t )
dt
 This a dynamic optimization problem where one is
required to formulate the Hamiltonian function. The
current value of the Hamiltonian function is given by
L  B ( H (t ))  C ( H (t ), X (t ))  p(t ) F ( X (t ))  H (t )
 Solve for H (t ), X (t ) and p(t ) . p(t) is shadow price.
 Fisheries regulation
 Harvesting can be controlled through the application of
Pigou tax.
 The competitive resource exploiter behaves as if the
shadow price  (t ) (sometimes called the user cost) of
the resource were zero.
 A management agent can, in principle at least, force
exploiters to recognize the shadow price by imposing it
as a tax on harvests.
 Under this set up, the entire resource rent is captured for
the public purse by means of the resource tax, and the
management agency acts as the sole owner of the
resource, charging rent for its use.
MATHEMATICS OF RESOURCE REGULATION

 Suppose there are N potential exploiters of a renewable

resource stock, with cost functions ci ( Ei ), i  1,, N ,
and with identical production functions, hi   ( X , Ei ).
 If the price of the harvested resource is p each exploiter
attempts to his/her short term net revenues:
Max Ei  0  p  ( X , Ei )  ci ( Ei )
 ( X , Ei )
 ci ( Ei )  p  (1)
Ei
 The exploiter simply equates marginal cost to marginal
revenue. Because of stock externality, this is not a
social/cooperative optimum.
 What would be a cooperative optimal?
MATHEMATICS OF RESOURCE REGULATION
CONTINUED……….
 The cooperative optimum would be:
Max  e t   p  ( X , Ei )  ci ( Ei ) dt


0
i

subject to X  F ( X )    ( X , Ei )
i
 The current-value Hamiltonian is:
 
L    p ( X , Ei )  ci ( Ei )   (t )  F ( X )    ( X , Ei )
i  i 
 One of the necessary conditions is that the current value
Hamiltonian is concave in X and E , or
 ( X , Ei )
ci( Ei )  ( p   )  (2)
Ei
 Where  is the shadow price. It is the marginal value of
the resource stock and therefore positive in all cases.
 MATHEMATICS OF RESOURCE
REGULATION CONTINUED……….
 Comparing equations (1) and (2) in the above slides, it
follows that the competitive resource exploiters always
exert excessive levels of effort, relative to the
cooperative optimum.
 If the price received by the exploiter is reduced by the
amount of the shadow price, then the exploiter will exert
the optimal level of effort.
 In other words, a tax on resource harvest equal to the
shadow price causes competitive resource exploitation
to coincide with the optimum.
 This a dynamic version of Pigou’s theorem.
 The applicability of the dynamic Pigou tax can be far
from perfect because of the difficulties involved in
computing the shadow price .
ECONOMICS OF FORESTRY MANAGEMENT
CHARACTERISTICS OF FOREST RESOURCES

 Forests are multi-functional, provide a wide variety of

goods and services.
 Woodlands are capital assets

 Trees exhibit very long lags between the date of

planting and the date of attaining biological maturity.
 Unlike fisheries, tree harvesting does not involve a
regular cut of the incremental growth
 Plantation forestry is more controllable than commercial
marine fishing
 Trees occupy valuable land, the land taken up in
forestry has opportunity cost
 The growth in volume or mass of a single stand of
timber, planted at one point in time, resembles that of
fisheries.
 CLAWSON (1977) MODEL OF TIMBER VOLUME
 Let X (t ) denote the volume of timber, in cubic feet,
of standing timber and t is the age in years of the
stand since planting.
 Clawson assumed a cubic function taking the
following form:
X (t )  at  bt 2  ct 3
 We can plot the volume of timber over a given time
period as in the following slide.
 CLAWSON (1977) MODEL OF TIMBER
VOLUME CONTINUED……………
 Clawson graph

X (t )

0 t years
 OPTIMAL FOREST ROTATION
 Let V (t )denote the stumpage value for a given stand
of trees of age years.tSo we typically have:
V (t )  0 for 0  t  t1
V (t )  0 for t  t1
 t revenue will be
If the forest is clear-cut at age net
given by:   V (t )  c
 Where
c
represents total cost of clear-cutting and
replanting. After replanting a new rotation is begun.
 The problem is to determine the optimal rotation
t T
period .

 We assume a discount rate of and also assume
that all parameters remain constant over time e.g. soil
productivity, price, discount rate and replanting costs
 OPTIMALITY

 Given the assumptions in the above slide, it is

obvious from the principle of optimality that all
rotation periods will have the same length T.
 The total net present value of all future forest
cuttings is; NPV  V (T )  c . e t  e 2T  .....
V (T )  c

eT  1
 The optimal rotation period T is then obtained by
setting: d ( NPV )
0
dT
 The resulting equation is known as the Faustmann
equation given as: V (T ) 

V (T )  c 1  e T
 A SINGLE ROTATION FOREST MODEL

 If the forest is clear-cut at age T then the present

value of profits is: ( P  c) X T e iT  k  pX T e iT  k
 where X T , k , c, p and i are the volume of timber
available for harvest at time T, planting costs,
marginal harvesting costs, net price of harvested
timber and the private consumption discount rate,
respectively.
 The present value of profits is maximized at the
 iT
value T which gives the highest value for pX T e k
 We therefore differentiate the above function with
respect to T using the product rule, set the
derivative equal to zero and then solve for T.
 OPTIMALITY IN A SINGLE ROTATION
FOREST MODEL ………….
We have: d
  d

( pX T )e iT  k  ( pX T e iT )
dT dT
 iT dX de iT
 pe  pX T 0
dT dT
 iT dX
 pe  ipX T e iT  0
dT
dX
 i  dT
XT
 The present value of profits is maximized when the
growth rate of the resource stock is equal to the
private discount rate.
INFINITE ROTATION FORESTRY MODELS

 When harvesting of one stand of timber is to be

followed by the establishment of another, an
additional element enters into the optimality
calculations.
 A decision to defer harvesting incurs additional cost
over that in the previous model.
 A delay in harvest has an opportunity cost in the form
of interest that is forgone on the delayed revenues
from harvesting.
 There is opportunity cost from a delay in establishing
the next and all subsequent planting cycles.
 Timber that would have been growing in subsequent
cycles will have later starts.
 OPTIMAL ROTATION

 An optimal harvesting and replanting programme

must equate the benefits of deferring harvesting
(the rate of growth of the undiscounted net benefit
of the timber stand) with the costs of deferring that
planting (the interest rate and the return lost from
the delay in establishing following plantings).
 We maximize the net present value from the infinite
sequence of rotations which is equal to the sum of
the net present values from each of the individual
rotations.
 The end result gives the Faustmann rule, that is:
dX
p  ipX T  i
dT
 HOTELLING RULE
 The Faustmann rule in the previous is a Hotelling
dynamic efficiency condition for timber harvesting.
Dividing it by the volume of timber we obtain:
 dX 
p 
 dT   i  i
pX T pX T
 With optimal rotation interval, the proportionate rate
of return on the growing timber is equal to the
interest rate that could be earned on the capital tied
up in the growing timber plus the interest that could
be earned on the capital tied up in the site value of
the land expressed as a proportion of the value of
growing timber.
 MEASURING NATIONAL INCOME

 Assume a closed economy

 Net Domestic Product (NDP) equals consumption plus
investment, i.e. NDPt  Ct  I t  (1)
 Investment here is in reproducible capital but if
production requires inputs of non-renewable resource as
well as reproducible resource then there is need to adjust
the domestic product.
 The Environmentally adjusted Domestic Product (EDP)
is given by: EDPt  NDPt  QRt Rt  NDP t  ht Rt  ( 2is
, where )
the marginal
QRt product of the resource in production, is
the amount used and
Rt is the Hotelling rent. ht
 In this model the resource extraction is costless.
 HARTWICK RULE

 Substituting equation (1) into (2), we obtain:

EDPt  Ct  I t  ht Rt  (3)
 From equation (3), if total net investment is zero
(investment in reproducible capital equals resource
depreciation) then consumption equal to sustainable
income – Hartwick rule.
 The Hotelling rent times resource use is interpreted as
the depreciation in resource stock.
 MEASURING NATIONAL INCOME WHEN THERE
ARE COSTS OF EXPLORATION AND EXTRACTION

 If there are extraction costs and there is exploration activity

that can increase the size of the known resource stock then:

EDPt  NDPt  (QRt  GRt )( Rt  N t )

 Where  NDP
is the t  ht ( Rt 
marginal N t )  (of
product 4) the resource, is
marginalQextraction
Rt cost, and is additions to the known GRt
non-renewable stock as a result of exploration. Nt
 Where extraction is costless the Hotelling rent is bigger
since it is the difference between the marginal product of the
resource and its marginal cost of extraction.
RENEWABLE RESOURCE AND NATIONAL
INCOME ACCOUNTING
 Suppose that a renewable resource rather than a non-
renewable resource is used in production.
 Then we have:

EDPt  NDPt  (QRt  GRt )( Rt  F ( X t ))

 NDPt  ht ( Rt  F ( X t ))  (5)
 Where GRtis the marginal cost of harvesting, and is the
F(Xt )
growth function for the resource stock, where is the X t
stock size.
 For sustainable yield harvesting of the renewable resource,

t no
, thereRis depreciation
F(X t) to account for; .
EDPt  NDPt
 ACCOUNTING OF RENEWABLE
RESOURCES OF DIRECT INTEREST
TO CONSUMERS

 While some renewable resources are solely of economic

interest as an input to production, some are also of direct
interest to consumers, e.g. Trees in the Vumba mountains
are used for timber when cut and for recreational
services when standing.
 In such a case we have:

 MU X t 
EDPt  NDPt    X t  ht  Rt  F ( X t )   (6)
 MU new
 Where the introduced 
Ct  term is the ratio of marginal

utility of standing trees to marginal utility of produced
timber for consumption.
ACCOUNTING OF RENEWABLE RESOURCES
OF DIRECT INTEREST TO CONSUMERS………

 The adjustment in equation (6) in the previous slide is

for the amenity value of standing trees.
 Ratio of utilities is used because of the absence of
observable market price for the amenity services of
standing trees.
 However, some methods can be used to value such
services (CVM, TCM, HPM)
 The adjustment suggested in equation (6) can be done
following some tests for . MU X  0
t

 If this is true then there is no need to include amenity

values in adjusting the domestic product.
 SYSTEM OF INTEGRATED ENVIRONMENTAL
AND ECONOMIC ACCOUNTING (SEEA)
 Proposed by the United Nations Statistical Division
following the increased interest in sustainable
development.
 The central idea is to measure environmental cost (EC)
of economic activity in a period. EC is defined as the
difference between the opening and closing value of the
stock of environmental assets, i.e.
ECt   ait vit   ait 1vit 1  (7)
 Where the summation is over assets,
i  1,2,....., n
ai and viare the physical measure and value of
th
the i environmental asset and t-1 refers to the
start of the period and t to the end of the period.
 SYSTEM OF INTEGRATED ENVIRONMENTAL AND
ECONOMIC ACCOUNTING (SEEA) CONTINUED…

 For the i th
environmental asset, ait vit  aisit 1its
vit 1
depreciation over the period. isEC
the
t change in the
balance sheet value of all n environmental assets over
the period, the depreciation of natural capital.
 Environmentally Adjusted Net Domestic Product could
then be defined as:

EDPt  NDPt  ECt  (GDPt  DMt )  DNt

 Where NDP is the Net Domestic Product, is the
DM
depreciation of man-made reproducible capital and
is the depreciation of natural capital.
DN  EC
 SATELLITE ACCOUNTS
 The UNSTATS proposals do not envisage replacing the
publication of the standard GDP/NDP accounts with the
publication of EDP accounts.
 They envisage complementing the standard accounts
with balance sheets for natural capital, from which users
of the accounts could work out EDP.
 This leaves the current conventions for the measurement
of GDP and NDP intact, so that adoption of the proposal
would mean that figures on these constructs would
continue to be available on a consistent basis with past
data.
 The balance sheets for environmental assets are therefore
called “satellite accounts”.
 MEASURING DEPRECIATION OF NON-RENEWABLE
RESOURCES: PERFECTLY COMPETITIVE MARKET
 Theoretically, the correct measure of the depreciation of a non-
renewable resource is the total Hotelling Rent (THR) arising in
its extraction.
 Taking P, c, R, N , and
to D
be the price of the extracted resource,
the marginal cost of extraction, the amount extracted, the new
discoveries and the depreciation of the resource stock,
respectively.
 We have: D  THR  ( P  c)( R  N )  (1)
 In a perfectly competitive market we have THR CIV
where CIV
is the change in the value of the stock of the renewable resource.
Depreciation (D) could therefore be measured as either THR or
CIV.
 These methods are not used in practice because the marginal
cost of extraction is not observable in published or readily
available data.
 PRACTICAL MEASUREMENT OF A NON-
RENEWABLE RESOURCE DEPRECIATION

 The commonly used methods are the net price, the

change in net present value and the El Serafy’ user cost
rule.
 These three methods have been applied in a number of
empirical studies.
 THE NET PRICE
 Uses average cost (C) instead of marginal cost to
compute the rent which is taken as the measure of
depreciation, i.e. D = (P – C)(R – N) …… (2)
 For c > C, P – C > P – c so there would arise an over-
estimation of THR using equation (2).
 In many applications of the net price method, N is
ignored.
 P and C could be measured at the start or the end of the
period, or some average over the period. The three
measures could only coincide if P and C are unchanging
which is not common with P.
 CHANGE IN NET PRESENT VALUE

 Let 0 indicate the start of the accounting period and 1 is

close then:
T0
  Pt  Ct  Rt  T1   Pt  Ct  Rt 
D       (3)
t  0  1  r   t 1  1  r  
t t

 Where T0 and Tare

1 deposit lifetimes, and is ther interest
rate. Apart from the use of C rather than c, this method
can be seen as an alternative, to stock market valuations,
method of measuring CIV.
 The method however requires some assumptions as
discussed in the El Serafy’ user cost rule.
 EL SERAFY’S USER COST RULE

 Depreciation is measured as user cost

 The rule simply states that:
R P  C 
D  (4)
1  r  T 1

 Where r is the interest rate and T is the deposit lifetime

assuming a constant rate of extraction.
 It is assumed that from net receipts from sales a certain
proportion is set aside and invested at a constant rate of
return in order to yield a constant level of income
indefinitely.
 The user cost is then defined as the difference between
net receipts and that constant income regarded as
sustainable or true income from resource depletion.
 SIYABONGA!!!

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