Chapter Four

Natural Resource
Part I
 4.1. Classification of Natural Resources
* In a broad sense, natural resources refer to all the living and
nonliving endowment of the earth, but traditional usage
confines the term to naturally occurring resources and
systems that are useful to humans, or could be made useful
under ordinary technological, economic, social, and legal
circumstances.
* On the basis of origin, resources may be divided into: biotic
and abiotic.
* Biotic resources are obtained from the biosphere, such as
forests and their products, animals, birds and their products,
fish and other marine organisms. Mineral fuels such as coal
and petroleum are also included in this category because they
are formed from decayed organic matter.
* Abiotic resources include non-living things. Examples
include land, water, air and ores such as gold, iron, copper,
silver etc.
* Consideringtheir stage of development, natural resources
may be referred to in the following ways: potential
resources and actual resources.
* Potential resources are those that exist in a region and may
be used in the future. For example, petroleum may exist in
many parts of a nation, having sedimentary rocks but until
the time it is actually drilled out and put into use, it remains
a potential resource.
* Actual resources are those that have been surveyed, their quantity
and quality determined and are being used in present times.
* The development of an actual resource, such as wood processing
depends upon the technology available and the cost involved. That
part of the actual resource that can be developed profitably with
available technology is called a reserve.
* With respect to renewability, natural resources can be categorized
as into renewable and nonrenewable resources.
* Renewable resources are ones that can be replenished or
reproduced easily. Some of these, like agricultural crops, take a
short time for renewal; others, like water, take a comparatively
longer time, while still others, like forests, take even longer.
* Renewable resources are defined as resources that are regenerated
on a human time scale.
*A natural resource is a renewable resource if it is
replaced by natural processes at a rate comparable
or faster than its rate of consumption by humans.
*Renewable resources may also mean commodities
such as wood, paper, and leather, if harvesting is
performed in a sustainable manner.
* As renewable, one may cite solar energy, wind
energy, tidal energy, farmland, forest, fisheries, air,
and surface water. Some of them, like sunlight, air,
wind, etc., are continuously available and their
quantity is not affected by human consumption.
* Some renewable resources can be stored; others cannot. For
those that can, storage provides a valuable way to manage
the allocation of the resource over time. We are not left
simply at the mercy of natural outgoing tide and flows of the
source.
* For example while solar energy can be stored in many
forms, the most common natural form of storage occurs
when it is converted to biomass by photosynthesis.
* Storage of renewable resources usually performs a different
service from storage of depletable resources. Storing
depletable resources extends their economic life; storing
renewable resources, on the other hand, can serve as a means
of smoothing out the cyclical imbalances of supply and
demand.
*A non-renewable resource is a natural resource which
cannot be produced, grown, generated, or used on a
scale which can sustain its consumption rate.
*These resources often exist in a fixed amount, or are
consumed much faster than nature can create them.
Non-renewable resources can be considered as a stock
that has a regeneration rate of zero over a relatively
long period.
*For non-renewable resources, although geological
processes may be capable of generating new stocks for
a given resource along time (geologic time), the human
time scale does not allow coping with such
renewability.
* Non-renewable resources are formed over very long
geological periods. Minerals and fossil fuels are included
in this category. Since their rate of formation is extremely
slow, they cannot be replenished once they get depleted.
* Of these, the metallic minerals can be re-used by
recycling them. But coal and petroleum cannot be
recycled.
* Depletable (or non-renewable) resources can be classified
into two categories: recyclable and non-recyclable
resources.
*Current depletable-recyclable resources can be
augmented by economic replenishment as well as by
recycling. Recyclable resource here refers to a
resource which is currently in use for one purpose and
exists in a form that allows its mass to be recovered
once the very purpose is no longer necessary or
desirable.
*Economic replenishment is stimulated by prices when
resources are widely been explored at increasing
demand for it or by using advance technology to
explore and exploit resources more vigorously. As
price rises, producers find it profitable to explore more
widely, dig more deeply, and use lower-concentration
ores, and so on.
* Here it is to be noted that rate of depletion depends upon
durability of the product in which resource is being used
and the ability of the product to be reused.
* Current depletable non recyclable resource may also be
categorized into storable and non storable resources.
* For example, Helium is always commingled with common
gases. If Helium is not captured and stored simultaneously, it
defuses in air. Thus the useful stock of helium depends upon
how much it is decided to be stored.
* It is also significant to note that Law of Entropy suggests
that 100% recycling of recyclable resource is not possible.
And also, endowment of depletable resources is finite. Thus
current use of depletable non-recyclable resources precludes
future use.
*Another approach to classification is to define
natural resources according to their geographic
concentration in other words, is the
availability of the resource restricted to
geographically small areas or does it spans
larger areas?
* For example, forests cover wide areas and are
therefore considered to be diffuse resources.
Point resources are highly concentrated and do
not have a significant areal extent on a map.
For example, many minerals occur in small
areas, and on a map, these deposits are
represented as points.
4.2. Theory of optimal depletion
4.2.1. Non renewable resource
4.2.1.2. Non-renewable resource two-period model
*Non-renewable resources include fossil-fuel energy
supplies oil, gas and coal – and minerals – copper and
nickel, for example.
*They are formed by geological processes over millions
of years and so, in effect, exist as fixed stocks which,
once extracted, cannot be renewed.
One question is of central importance: what is the
optimal extraction path over time for any particular
non-renewable resource stock?
*When do we say that non renewable
resources are heterogeneous? What is its
effect on resource depletion and production
path?
*Substitution will take place if the price of the
resource rises to such an extent that it makes
alternatives economically more attractive.
*Consider, for example, the case of a country
that has been exploiting its coal reserves, but
in which coal extraction costs rise as lower-
quality seams are mined.
*Meanwhile, gas costs fall as a result of the
application of superior extraction and distribution
technology.
*A point may be reached where electricity producers
will substitute electricity for gas in power generation.
It is this kind of process that we wish to be able to
model in this chapter.
*For much of the discussion in this chapter, it is
assumed that there exists a known, finite stock of
each kind of non-renewable resource. This
assumption is not always appropriate. New
discoveries are made, increasing the magnitude of
known stocks, and technological change alters the
proportion of mineral resources that are economically
recoverable.
 A non-renewable resource two-period model
*Consider a planning horizon that consists of
two periods, period 0 and period 1.
*There is a fixed stock of known size of one
type of a non-renewable resource.
*The initial stock of the resource (at the start
of period 0) is denoted R.
*Let Rt be the quantity extracted in period t
and assume that an inverse demand function
exists for this resource at each time, given by
Pt = a − bRt
* Pt is the price in period t, with a and b being positive constant
numbers. So, the demand functions for the two periods will be:
P0 = a − bR0
P1 = a − bR1
*A linear and negatively sloped demand function such as
this one has the property that demand goes to zero at
some price, in this case the price a. Hence, either this
resource is non-essential or it possesses a substitute
which at the price a becomes economically more
attractive.
*The assumption of linearity of demand is arbitrary and
so you should bear in mind that the particular results
derived below are conditional upon the assumption that
the demand curve is of this form.
* The shaded area of the demand curve (algebraically, the
integral of P with respect to R over the interval R = 0 to
R = Rt) shows the total benefit consumers obtain from
consuming the quantity Rt in period t.
* From a social point of view, this area represents the
gross social benefit, B, derived from the extraction and
consumption of quantity Rt of the resource. We can
express this quantity as

* The notation B(Rt) is used to make explicit the fact that

the gross benefit at time t, (Bt), is dependent on the
quantity of the resource extracted and consumed (Rt).
*However, the gross benefit obtained by consumers is
not identical to the net social benefit of the resource, as
resource extraction involves costs.
* Let us assume these costs are fully borne by the
resource-extracting firms, and so private and social
costs are identical.
* Let us define c to be the constant marginal cost of
extracting the resource (c ≥ 0). Then total extraction
costs, Ct, for the extracted quantity Rt units will be
Ct = cRt
The total net social benefit from extracting the quantity
Rt is
NSBt = Bt − Ct
* In the above equation NSB represents the net social benefit,
Ct represents the total cost and Bt represents the total
benefit. Hence

Socially optimal extraction policy

*In order to find the socially optimal extraction
programme, two things are required.
*The first is a social welfare function that
embodies society’s objectives.
*The second is a statement of the technical
possibilities and constraints available at any
point in time.
* The social welfare function that we shall use is discounted
utilitarian in form. So the general two-period social welfare
function will be

* Where ρ is the social utility discount rate, reflecting

society’s time preference.
* Now regard the utility in each period as being equal to the
net social benefit in each period and the resulting social
welfare function would become

* Only one relevant technical constraint exists in this case:

there is a fixed initial stock of the non-renewable resource,
* We assume that society wishes to have none of this resource
stock left at the end of the second period. Then the quantities
extracted in the two periods, R0 and R1, must satisfy the
constraint

* The optimization problem can now be stated. Resource

extraction levels R0 and R1 should be chosen to maximize
social welfare, W, subject to the constraint that total
extraction of the resources over the two periods equals .
* Thus the maximization function would become
* There are several ways of obtaining solutions to constrained
optimization problems of this form. Here we have applied the
Lagrange multiplier method.

* Let us derivate the Lagrange function with respect to R0 and R1.

* Since the right-hand side terms of both equations above are both
equal to zero, this implies that
* Usingthe demand function mentioned earlier, this function
would become

* Where P0 and P1 are gross prices and P0 − c and P1 − c are

net prices.
* A resource’s net price is also known as the resource rent or
resource royalty.
* Rearranging this expression, we obtain

* Commonly known as the Hotelling’s rule.

* The left-hand side of the equation, ρ, is the social utility
discount rate, which embodies some view about how future
utility should be valued in terms of present utility.
* The right-hand side is the proportionate rate of growth of the
resource’s net price.
* So if, for example, society chooses a discount rate of 0.1 (or
10%), Hotelling’s rule states that an efficient extraction
programme requires the net price of the resource to grow at a
proportionate rate of 0.1 (or 10%) over time.
* Now we know how much higher the net price should be in
period 1 compared with period 0, if welfare is to be
maximized; but what should be the level of the net price in
period 0?
* Recall that the economy has some fixed stock of the
resource that is to be entirely extracted and consumed in the
two periods. Also, we have assumed that the demand
function for the resource is known.
* An optimal extraction programme requires two gross prices,
P0 and P1, such that the following conditions are satisfied:
P0 = a − bR0
P1 = a − bR1
𝑹𝟎+𝑹𝟏=𝑺 ̅
 A non renewable resource multi period model
* It will be convenient to change from a discrete-time
framework (in which there is a number of successive
intervals of time, denoted period 0, period 1, etc.) to a
continuous-time framework which deals with rates of
extraction and use at particular points in time over some
continuous-time horizon.
* P is now defined to be the net price of the non-renewable
resource, that is, the price after deduction of the cost of
extraction.
* Let P(R) denote the inverse demand function for the
resource, indicating that the resource net price is a function
of the quantity extracted, R.
* The social utility from consuming a quantity R of the
resource may be defined as the integration of demand
function with respect to R.

* By differentiating total utility with respect to R, the rate of

resource extraction and use, we obtain

which states that the marginal social utility of resource use

equals the net price of the resource.
* Assume, as for the two-period model, that the intertemporal
social welfare function is utilitarian. Future, utility is
discounted at the instantaneous social utility discount rate ρ.
Then the value of social welfare over an interval of time
from period 0 to period T can be expressed as
* Our problem is to make social-welfare maximizing choices
1. We wish to choose a quantity of resource to be extracted in
each period (Rt)
2. The optimal value for T (the point in time at which
depletion of the resource stock ceases), subject to the
constraint that is

where is the total initial stock of the nonrenewable resource.

That is, the total extraction of the resource is equal to the size
of the initial resource stock. Note that in this problem, the time
horizon to exhaustion is being treated as an endogenous
variable to be chosen by the decision maker.
* We define the remaining stock of the natural resource at time
t, St , as

* By differentiation with respect to time, we obtain

* And it represents of change of the remaining resource stock

with respect to time
* The dynamic optimization problem involves the choice of a
path of resource extraction Rt over the interval t = 0 to t = T
that satisfies the resource stock constraint and which
maximizes social welfare, W.
*The optimization point will be found where the
discounted marginal utility from the extracted quantity
is the same in each period.
*If not the resource extraction will be postponed to the
time where it can generate higher marginal utility.
*Do not forget that the marginal utility from resource
extraction in this case is equal with net price associated
with it.