Natural Resources and Environmental

Economics

Course Code: AgEc 421

ECTS: 5

By Lemi Gonfa

WSU, 2023
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 Introduction
• Economics is the study of the ALLOCATION of
SCARCE resources to meet UNLIMITED human
wants.
• Economics is a social science, which studies how
societies allocate scarce resources in the
production and distributes of goods and services
so as to attain the maximum fulfillment of society’s
material wants.

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 Introduction
What is Environmental economics?
A “standard” economic approach considers the economy as
consisting of flows of goods and services between firms and
households, influenced by the policy of governments.

 Environmental economics adds to this the flow of

resources from the environment (energy, raw materials, and
so on) and the flow of waste products passing to the
environment (various forms of pollution, solid waste, and so
on).
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• Environmental economics has come into existence
due to the realization that humans can no longer
ignore the effects they have on the environment
through using resources and creating pollution.

• The “standard” model is fine for a world with low

population, abundant resource, and no lasting
environmental damage, but we no longer live in such
a world.

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• More recently, a slightly different approach has
arrived:
• ecological economics goes further than
environmental economics, in recognizing
not only the flows between economy and
environment, but also the complicated
interactions and dynamics, which can arise,
between human activity and ecosystems as
a whole.
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 So environmental economics is:
 Concerned with the significance of the environment and
its impact of the economy
 Appropriate way of regulating economic activity so that
a balance is achieved among environmental, economic
and other social goals.
 Economics generally rely on markets to match producer
costs with consumer demands, with environmental goods,
more difficult.
 Environmental and natural resource economics is the
application of economics to the study of how environmental
and natural resources are developed and managed.
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 Natural resources vs Environmental resources

 Natural resources - resources used as inputs to production

of goods and services Two types
• Renewable - the resource can be replenished like, Fish,
cattle, fruits, etc.
• Nonrenewable - once the resource is used, it is
gone forever, like: Petroleum - diesel fuel, gasoline,
plastics
 Environmental resources - resources provided by nature
that are not utilized by humankind directly
• Parks and wild life
• Usually impacted by pollution 7
 Issues in resource economics

• Types of resources
– Non-renewables
• Minerals, oil, gas, coal
– Renewables
• Fish, forests, water
• Questions to be studied
– Optimal depletion of non-renewables
– Optimal harvesting of renewables

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 Four features of the economic approach to
resource and environmental issues
1. Property rights, efficiency and government
intervention
2. The role, and the limits, of valuation, in achieving
efficiency
3. The time dimension of economic decisions
4. Substitutability and irreversibility

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 1. Property rights, efficiency and
government intervention
• A central question in resource and environmental
economics concerns allocative efficiency.
• The role of markets and prices is central to the analysis
of this question.
• As noted, a central idea in modern economics is that,
given the necessary conditions, markets will bring
about efficiency in allocation.
• Well-defined and enforceable private property rights
are one of the necessary conditions.

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 1. Property rights, efficiency and government
intervention
• Because property rights do not exist, or are not clearly
defined, for many environmental resources, markets
fail to allocate those resources efficiently.
• In such circumstances, price signals fail to reflect true
social costs and benefits, and a prima facie case exists
for government policy intervention to seek efficiency
gains.
• Deciding where a case for intervention exists, and
what form it should take, is central in all of resource
and environmental economics.
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 2. The role, and the limits, of
valuation, in achieving efficiency
• As just observed, many environmental resources–or
the services yielded by those resources–do not have
well-defined property rights. Example: Clean air.

• Such resources are used, but without being traded

through markets, and so will not have market prices.

• A special case of this general situation is external

effects, or externalities.

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 2. The role, and the limits, of
valuation, in achieving efficiency
• An externality exists where a consumption or
production activity has unintended effects on
others for which no compensation is paid.

• Here, the external effect is an untraded–and

unpriced–product arising because the victim
has no property rights that can be exploited to
obtain compensation for the external effect.

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 2. The role, and the limits, of
valuation, in achieving efficiency
• However, the absence of a price for a resource or an
external effect does not mean that it has no value.

• Clearly, if well-being is affected, there is a value that

is either positive or negative depending on whether
well-being is increased or decreased.

• In order to make allocatively efficient decisions,

these values need to be estimated in some way.
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 3. The time dimension of economic decisions
• Natural resource stocks can be classified in various
ways.
• A useful first cut is to distinguish between ‘stock’
and ‘flow’ resources.
» stock resources are resources that have the
characteristic that today’s use has implications
for tomorrow’s availability
• Eg.
• plant and animal populations and
• mineral deposits, 15
 3. The time dimension of economic
decisions
• flow resources the level of use today does not have
implications for availability tomorrow.
• Eg.
– solar radiation, and
– power of the wind, of tides and
– flowing water.
• Using more solar radiation today does not itself
have any implications for the availability of solar
radiation tomorrow.
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 3. The time dimension of economic
decisions
• Within the stock resources
– ‘renewable’ and
– ‘nonrenewable’ resources.

• Renewable resources are biotic, plant and animal

populations, and have the capacity to grow in size
over time, through biological reproduction.

• Non-renewable resources are abiotic, stocks of

minerals, and do not have that capacity to grow over
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time.
 3. The time dimension of economic
decisions
• What are here called non-renewable resources are
sometimes referred to as ‘exhaustible’, or ‘depletable’,
resources.

• This is because there is no positive constant rate of use

that can be sustained indefinitely–eventually the
resource stock must be exhausted.

• Renewable resources are also exhaustible if harvested

for too long at a rate exceeding their regeneration
capacities. 18
 3. The time dimension of economic
decisions
• From an economic perspective, stock resources are assets
yielding flows of environmental services over time.

• In considering the efficiency and optimality of their use,

we must take account not only of use at a point in time
but also of the pattern of use over time.

• Efficiency and optimality have, that is, an intertemporal,

or dynamic, dimension, as well as an intratemporal, or
static, dimension.
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 4. Substitutability and irreversibility
• Substitutability and irreversibility are important, and
related, issues in thinking about policy in relation to the
natural environment.
• If the depletion of a resource stock is irreversible, and
there is no close substitute for the services that it provides,
then clearly the rate at which the resource is depleted has
major implications for sustainability.
• To the extent that depletion is not irreversible and close
substitutes exist, there is less cause for concern about the
rate at which the resource is used.

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 4. Substitutability and irreversibility
• Human-made capital is sometimes referred to as
reproducible capital, identifying an important
difference between stocks of it and stocks of
nonrenewable resources.
• The latter are not reproducible, and their exploitation
is irreversible in a way that the use of human-made
capital is not.
• With renewable resource stocks, depletion is reversible
to the extent that harvesting is at rates that allow
regeneration.
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 1.2.Types and definitions of natural resource

The resources of land, forests, savannahs and seas fall into

several categories. Two main types of natural resource can
be distinguished
(a) Non-renewable natural resources
(b) Renewable natural resources
Non-renewable natural resources are those of fixed
supply such as oil, coal, gold or iron – that is, their
continued use will inevitably result in exhaustion.
Renewable natural resources are those that have the
capacity to regenerate themselves, and are therefore
potentially inexhaustible when used appropriately, e.g.
fish, forests, solar energy, water, and the atmosphere. 22
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• Environmental resources, on the other hand, are those that
are of benefit to humankind but are difficult, if not
impossible, to own: what economists refer to as ‘public
goods’.
• Many of these are based on a functioning ecosystem.
Examples include clean air, flowing rivers, the existence of
particularly plants and scenic beauty.

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 Ecological and economic importance
of biodiversity
• From an ecological perspective, the diversity increases the
ecosystem's stability (capacity to maintain itself into healthy
margins of variation adapting recurrently to changes) and
resilience (ability to respond and recover to great stress
events), which is an extraordinary quality, because it means
that biodiversity is able to maintain itself in the time, owing to
the called biogeochemical cycles:
• Energy,
• Water,
• Carbon and oxygen cycles
• Nitrogen cycle
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• From economics perspective, biodiversity is important in
terms of its use or potential use value to society i.e. a
‘utilitarian’ view. These uses, which are discussed further in
Chapter 4, include:
• Extractive use encompasses direct use of biological
resources, for either production or consumption:
– Fuel wood, timber, water, fish, ivory, medicinal
plants, fodder, construction material, dyes, etc.
– Employment

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 1.4. The role of public policy in ensuring efficient
and equitable natural resource allocation
 As the twenty-first century begins it is clear that the welfare
of humanity is closely linked to the quantity and quality of
the natural resources.
 Long ago, natural resources were a free good but today
they are a scarce good.
 It is also evident that governments in specific countries are
increasingly being confronted with natural resource linked
conflicts.
 This is because without consideration of peoples’
interests, sustainable natural resources conservation is
not possible.
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 Economic policies particularly influence the nature of
natural resources.
 It is now acknowledged that natural resources are not
merely biophysical entities but are also economic
commodities essentially dynamic and embedded in the
social and political setting.
 Therefore, appropriate natural resource management
(NRM) systems can only be developed if natural, economic
and governance components are appreciated and
integrated.
 This means that appropriated NRM systems are derived by
combining inputs from resource characteristics, policies,
institutions, technology, skills and economic signals.
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 1.5.Natural resources as scarce resources
Natural resources, often termed as “the free gifts of
nature”, are neither free nor finite.
Therefore, welfare of a society depends on how it allocates
its scarce natural resources among the competing needs by
making choices.
Economics as study of choice can contribute to natural
resource and environmental management by:
 Identifying circumstances which generate natural
resource problems
 Determining the causes of these problems
 Identifying possible solution and comparing their
cost and benefits
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• In making the choices, tradeoffs have to be made, that is
giving up one thing in order to get something else.
• Economists have three main areas where trade-offs are
made:
– what is produced with the available (natural)
resources such as land,
– how much is produced (food crops or forest
products) and
– for whom goods and services are produce (who
will enjoy the food crops and the forest products
produced from the land resource).

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• How do economists define the natural resources and the
environment (NRE)?
– Economists are interested in NRE as they affect mankind,
directly or indirectly.
– Therefore their definition and the changes they consider
in NRE are human centered.
– That is, they include not only short-run and direct effects
on mankind but indirect and long run effects as well.
• Economist view NRE as non-reproducible composite
capital asset or capital good that produces a stream of
various services to mankind as show in Figure 1.

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 Term Paper
Subject: The paper should provide a critical
evaluation of an environmental problem, policy,
or proposal, with particular attention to its
economic aspects.
The paper should illustrate that you can apply
some of the concepts and methods developed in
class to a real world problem.
It should not be limited to a simple description of
the issue, but should include your own economic
analysis.
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• Topics may be one of the following headings
(please note that this list is give to give you an
idea and it is not a complete list).
• Energy Water
• Agriculture Biodiversity
• Air pollution Acid rain
• Transportation Solid waste
• Sustainable development
• Non renewable resources

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Load(paper and presentation): 20%
In group of 4-6 students
Submission Date: June 02, 2023

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