Resource Economics

Introduction

Dr. Muhammad Irfan

 Natural Resource Economics
• The study of how natural resources are
allocated, managed, and utilized in economic
systems.
• It seeks to understand the economic principles
and policies that govern the extraction,
distribution, and conservation of natural
resources.
• It addressed issues related to sustainability,
resource depletion, and environmental
degradation.
 The Economy in the Environment
• The Environment is a thermodynamically closed
system, exchanging energy (but not matter) with its
environment.
• The economy is located within the environment.
• The environment provides four functions to the
economy
1. source of resource inputs
2. source of amenity services
3. receptacle for wastes
4. provides life support services
• These environmental functions interact with one
another in various ways, and may be mutually
exclusive
• There exist possibilities to substitute reproducible
capital for ‘natural capital’
Source: Thinkearth.org
 Thermodynamics
Open system
– exchanges energy and matter with its environment – an organism
Closed system
– Exchanges only energy with its environment – planet earth
Isolated system
– exchanges neither with its environment – the universe
First Law
– energy can be neither created nor destroyed. It can only be converted from
one form (chemical as in coal eg) to another (electricity).
Second Law
– all energy conversions are in terms of available energy less than 100% efficient
(not all of the energy in the coal becomes available as electricity).
Entropy Law
– Implies that all energy conversions are irreversible.
– which says that the entropy of an isolated system cannot decrease.
– Entropy is a measure of unavailable energy.
– Living systems are not subject to the second law as they are open
systems.
– it does apply to dead organisms.
 Sustainability
• For most of human history, human numbers and material
consumption levels were subject to this constraint.
• Sustainability refers to balanced use, management, and
conservation of natural resources to meet the needs of
current and future generations without depleting or
degrading these resources.
• The fossil fuels (which include coal, oil, and natural gas, are
non-renewable resources) are accumulated past solar energy
receipts, initially transformed into living tissue, and stored by
geological processes.
• Fossil fuels are being extracted and consumed at a rate that
far exceeds their natural replenishment.
 The Materials Balance Principle

• ‘The materials balance principle’ : also known as the

law of conservation of mass;
– matter can neither be created nor destroyed.
• Economic activity essentially involves transforming
matter extracted from the environment.
• All material extracted from the environment must,
eventually, be returned to it, albeit in a transformed
state.
 The Materials Balance Principle

The environment A ≡ B+C+D

Environmental firms A ≡A1+A2+C

Non-environmental firms B+R+E ≡ R+A1+F

Households A +E ≡ D+F
 Ecology
• Ecology is the study of the distribution and abundance of
plants and animals.
• Ecological footprint is:
– “the aggregate area of land and water in various
ecological categories that is claimed by participants in the
economy to produce all the resources they consume, and
to absorb all the wastes they generate on a continuing
basis, using prevailing technology.”
• The footprint size will vary with technology as well as with
levels and patterns of production and consumption.
• Meat and Dairy production
– requires a significant amount of resources such as
land, water, and feed.
 Biodiversity
• Biodiversity: the number, variety and variability of all living
organisms in terrestrial, marine and other aquatic ecosystems
and the ecological complexes of which they are parts.
There are three levels at which biodiversity can be considered:
• Population: genetic diversity within the populations that
constitute a species.
• Species: A species can be taken to be a set of individual
organisms which have the capacity to reproduce
• Ecosystems: in many ways, the diversity of ecosystems is the
most important measure of biodiversity; unfortunately, there
is no universally agreed criterion for either defining or
measuring biodiversity at this level.
 Importance of Biodiversity
• Diverse ecological systems facilitate environmental
functions, such as carbon cycling, soil fertility
maintenance, climate and surface temperature
regulation, and watershed flows.
• The diversity of flora and fauna in ecosystems
contributes to the amenity services that we derive from
the environment.
• In relation to inputs to production, those flora and fauna
are the source of many useful products, particularly
pharmaceuticals, foods and fibers.
• In terms of agriculture, biodiversity is the basis for crop
and livestock variability and the development of new
varieties.
PAKISTANOPLE’S WILLINGNESS TO PAY TO SAVE THE ENDANGERED
MARINE TURTLES OF PAKISTAN
The Current Extent of Biodiversity.
• We have very poor information about this.
• The number of species that currently exist is not known even
to within an order of magnitude.
• Estimates that can be found in the literature range from 3–10
million to 50–100 million.
• A current best guess of the actual number of species is 12.5
million.
• Even the currently known number of species is subject to
some dispute, with a representative figure being 1.7 million
species described to date.
• About 13000 new species are described each year.
 The Drivers of Environmental Impact
The environmental impact of economic activity can be
looked at in terms of:
• extractions from the environment
• insertions into the environment
• the size of the human population and
• the per capita impact.
The per capita impact depends on:
• how much each individual consumes, and
• the technology of production.
 Poverty and Natural Resource
• The income of the poorest 10% was 1.6% of that of the
richest 10%
• The richest 1% of the world population received as much
income in total as the poorest 57%
• Around 25% of the population received 75% of total income
• Factors
• Resource Exploitation and Overuse
• Deforestation:
• Soil Degradation:
• Pollution:
• Illegal Resource Extraction:
• Lack of Environmental Education:
• Vulnerability to Natural Disasters:
• Land Degradation:
• Loss of Ecosystem Services:
 Market Failure
• Market failure occurs when the allocation of
resources in a free market results in an
inefficient outcome,
– often due to externalities,
– incomplete information,
– the concentration of market power.
• Resources may be
– Over-allocated
– Under-allocated
 Demand and supply Side Failures

• Demand side
– Impossible to charge consumers what they are willing to
pay for the product
– Some can enjoy benefits without paying
• Supply side
– Occurs when a firm does not pay the full cost of producing
its output
– External costs of producing the good are not reflected in
the supply.
 Consumer and Producer Equilibrium

• Consumer Surplus
– Difference between what a consumer is willing to pay for a
good and what the consumer actually pays
– Extra benefit from paying less than the maximum price
• Producer Surplus
– Difference between the actual price a producer receives
and the minimum price they would accept
– Extra benefit from receiving a higher price
 Property Rights
• Property rights refer to the legal rights to possess, use, and
dispose of assets, resources, or property, whether tangible or
intangible.
– Ownership: Property rights establish ownership and ownership
claims, allowing individuals or entities to exclusively control and
benefit from their assets.
– Bundle of Rights: Property rights encompass a bundle of rights, which
include the right to use, enjoy, exclude others, transfer, and profit
from the property.
– Exclusivity: Property rights grant the holder the exclusive authority to
use and manage the property, preventing others from using it without
permission.
– Transferability: Property rights are often transferable, meaning that
owners can sell, lease, or transfer their property to others.
– Enforceability: Property rights are typically enforced by the legal
system, allowing owners to seek legal remedies in case of violation
 Types of Property
1. Private Property:
– It refers to assets, resources, or land that are owned and
controlled by individuals, businesses, or non-governmental
entities.
– Private property rights grant exclusive use, possession,
and decision-making authority over these assets, including
the right to buy, sell, lease, or transfer them.
2. Common Property:
– Common property, also known as common-pool
resources, refers to resources or assets that are
collectively owned or managed by a group of individuals or
a community.
– It include things like community grazing land, fishing
grounds, or shared forests.
3. Public Property:
– Public property, also known as state or government-owned
property, refers to assets, resources, or land that are owned
and controlled by a government or public authority.
– Public property includes things like public parks, government
buildings, roads, and infrastructure.
4. Open Access:
– Open access refers to a situation in which resources, often
natural resources, are accessible to anyone without restrictions
or ownership rights.
– Open access resources are typically not managed, and there are
no property rights, which can lead to overuse and depletion.
– Examples of open access resources include unregulated
fisheries or open-range grazing areas where anyone can access
and use the resource without constraint.
 Tragedy of Commons
• The tragedy of the commons is a concept often
associated with open access resources, highlighting
the potential for overexploitation when resources
are not managed or regulated.
 Example : Overgrazing of Common Pasture
• Imagine a village with several farmers who share access to a common
pasture for grazing their livestock. In this scenario:
• Initially Balanced: At first, each farmer has only a few animals, and the
common pasture is lush and well-maintained. The pasture can naturally
regenerate, providing ample grazing for everyone's livestock.
• Self-Interest Takes Over: Over time, each farmer decides to increase their
herd size to maximize their individual profit. The incentive is that more
livestock means more meat, milk, or other products to sell.
• Tragedy Unfolds: As each farmer adds more animals to the common
pasture, it becomes increasingly overgrazed. The pasture's vegetation
can't regenerate quickly enough to support the growing number of
animals.
• Depletion and Environmental Damage: The consequence is that the
pasture starts to deteriorate, and there is not enough grass for all the
animals. As a result, the animals become malnourished, the land becomes
barren, and there is long-term damage to the environment.
• Collective Loss: Ultimately, all the farmers suffer as the pasture's
productivity declines, and the quality of their livestock deteriorates. This is
the "tragedy of the commons" because the pursuit of individual self-
interest leads to collective harm.
 Coase Theorem:
• When property rights are fully specified,
assigned, transferable, divisible, secure and
transaction costs are zero
– Trade eliminates the pareto relevant externality
– Resource allocation is invariant to the initial
assignment of resources
• When property rights are fully specified,
assigned, transferable, divisible, secure and
transaction costs are zero (and zero income
effect)
• Trade eliminates the externality
• Final resource allocation is invariant to initial
assignment of resources/rights
 The Problem of the Cattle and the Rancher

• Scenario:
– Imagine a situation where there is a rancher and a
farmer living next to each other.
– The rancher raises cattle, and the farmer grows
crops.
– The rancher's cattle sometimes stray onto the
farmer's land, damaging the crops and causing
harm to the farmer.
 Application of the Coase Theorem:
• if transaction costs are low and property rights are clearly
defined,
• the rancher and the farmer can negotiate a solution to the
problem of cattle damaging crops without government
intervention.
• If the rancher's right to let his cattle roam is clearly defined
(i.e., he has the property rights), the farmer can approach
the rancher and offer compensation to keep the cattle
fenced in.
• Conversely, if the farmer has the property rights to a crop-
free area, the rancher can negotiate with the farmer to
allow his cattle to graze in exchange for compensation.
• In either case, the parties can reach an agreement that
minimizes the overall harm and maximizes their joint
welfare.
• The Coase Theorem demonstrates that, under certain
conditions, individuals can negotiate and reach efficient
solutions to externalities, regardless of the initial allocation
of property rights.
• It's important to note that the Coase Theorem assumes low
transaction costs, full information, and rational decision-
making by the parties involved. In the real world, these
assumptions may not always hold, and government
intervention may be necessary to address externalities.
 Example
• Imagine Ben and Jose sharing a room in hostel.
• Both Ben and Jose have equal access to the
room, and there are no rules or agreements
regarding its use.
• Let Ben wants to study for his upcoming exams, while
Jose wants to watch TV.
• What Ben is willing to accept to turn down the TV
tells you how much he values sound
• What Jose is willing to accept to turn up the TV
tells you how much he values quiet

MB of sound to Ben = MC of quiet to Jose

MB of quiet to Jose = MC of sound to Ben
 $

Ben MB of sound
Jose MB of quiet

Q Sound Q quiet
Jose: MB of quiet = MC of quiet
Ben: MB of sound = MC of sound
$ Jose MB of Quiet

Ben MB of Sound

Q sound Q quiet
 What if:
Jose lived there first, so Ben has to bribe him in order to watch
$ TV at an agreed upon volume

MC of sound

P
MB of sound

q Q sound
 What if:
Jose lived there first, so Ben has to bribe him in order to
$ watch TV at an agreed upon volume

MC of sound

P
MB of sound

q Q sound
 MB and MC curves drawn as linear for simplification
$

MC of sound

P
MB of sound

q Q sound
What if transaction costs are not
zero
Ben doesn’t speak Spanish, Jose doesn’t speak English
Jose has to bribe but the marginal benefit of each additional
amount of quiet is lower.
$

Jose
MB of quiet
MB’

Q quiet
$

Jose
MB quiet

p0

Ben
MB of sound
q0 q1
Q sound
Q quiet
Ben doesn’t speak Spanish, Jose doesn’t speak English
Ben
$ has to bribe, but the marginal benefit of the same
volume is lower.

MB of sound

MC of sound

MB’

q1 q0 Q sound
$

MC Jose has to pay Ben,

transaction costs are
MC’ smaller

p0

MB
q0 q1 Q sound
$

Ben has to pay Jose, MB

transaction costs are higher MC

MB’
q0 = q0 q1 > q1
p0

Jose bears lower transaction

costs so “gives up” less than q1 q0 Q sound
Ben.
 Case Study: Clean Air as a Public Good

• Possible Questions
– What are the key characteristics that define clean air as a
public good?
– How does pollution contribute to market failure in the
provision of clean air?
– What are the economic and health consequences of air
pollution, and how are they related to the public goods
problem?
– How has government policy, such as environmental
regulations, attempted to address the market failure
associated with clean air?
 National Defense as a Public Good

• Possible Questions
– Why is national defense considered a public good, and
how does it exhibit non-excludability and non-rivalry?
– What are the implications of free-riding in the context of
national defense?
– What are the economic and security implications of under-
providing or over-providing national defense?
 Examples for assignments
• Factory Noise and Nearby Residents:
• Airline Overbooking and Passengers:
• Fishing in a Shared Lake:
• Water Pollution from a Factory:
• Smoking in a Shared Workspace:
• Public Parks and Noise