UNIT O N E

Introduction to Natural & Environmental

Economics

Dagne Goshme (MSc)

 1.1. Definitions and Basic
What are Natural Resources?
Terms
 It is a naturally occurring, exploitable solid, liquid or gaseous
material in or on the earth‘s crust that society perceives to be
useful to its economic and material wellbeing.
 Its Location, grade, quality, and quantity are known or
estimated from specific evidence.
 In other words, natural resources are all these components of
the physical environment:-
 That are used by human beings to satisfy perceived needs
or requirements
 Found in nature or produce by nature; not artificial
 That have actual or potential value to man.
 Essential for human survival (e.g. Oxygen, Water etc)
 That have quantity, quality, time and space dimensions
Classifications of Natural
Natural resources could be classified in to different categories on the basis
Resources
of certain criteria. Such as :
I. On the basis of origin, resources may be divided into:
A.Biotic - Biotic resources are the ones which comprise of living
things. E.g..
Forests, animals, fish and other marine organisms.
B.Abiotic - Abiotic resources comprise of non-living things. Examples include
land, water, air and ores such as gold, iron, copper, silver etc.

II.Considering their status of development, natural resources may be classified

as:
A. Potential Resources - are those which exist in a region and may be used in
the future.
For example, petroleum may exist in some parts of Ethiopia having
sedimentary rocks but until the time it is not actually drilled out and
put into use, it remains a potential resource.
 The development of potential resource depends upon the
B. Developed Resources: Resources which have been surveyed
and their quality and quantity have been determined for utilization.
C. Stock: Resources which have the potential to satisfy our needs
but human beings do not have the appropriate technology to use
these.
For example, inflammable gases; hydrogen and oxygen are
compounds of water, which can be used as a source of energy. But we
do not have the required technical know-how‘ to use them for this
purpose.
D. Reserves are the subset of resources, which can be put into
use with the help of existing technical know-how‘ but their use has not
been started.
E.g. The water in the dams, forests etc. are a reserve which can
be used in the future.
Reserves can be subdivided into:-
I. Proven (the part of a resource that has been
discovered, measured, and has a known
III. With respect to renew ability, natural resources can be categorized as
follows
A. Renewable resources are the ones which can be replenished or reproduced
easily by nature or through purposeful human intervention.
E.g. sunlight, air, wind, etc., are continuously available and their quantity is
not affected by human consumption.
 Many renewable resources can be depleted by human use, but may also be
replenished, thus maintaining a flow. 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 can also be further grouped in to two:
I. Inexhaustible resources- are all those which remain unaffected by human
action.
E.g. the hydrological cycle assures that water, no matter how often used,
will return over and over to the land for future exploitation..
II. Exhaustible ones- those that are vulnerable to abuse. If the rate of
exploitation exceeds that regeneration, these resources can be depleted.
For example, ground water extracted beyond the replacement rate in arid
B. Non-renewable resources/ stock or depletable) resources –consists of finite
mass of materials which cannot be replenish themselves.
E.g. Minerals, non mineral resources, fossil fuels and other materials present in
fixed amounts in the environment. Such resources are formed over very long
geological periods.
Non-renewable natural resource can further be classified into several categories.
1.Identified resources: specific bodies of mineral-bearing material whose
location, quality and quantity are known from geological evidence, supported
by engineering measurements.
To reflect increasing degrees of certainty, these resources can be subdivided
into:-
a.Measured resources: material for which quantity and quality estimates are
made
from geologically known sample sites.
b.Indicated resources: material which quantity and quality have been estimated
partly from sample analyses and partly from reasonable geological projections.
c. Inferred resources: material in unexplored extensions of demonstrated resources
based on geological projections.
2.Undiscovered resources: unspecified bodies of mineral-bearing
material surmised to exist on the basis of broad geological
knowledge and theory.
a.Hypothetical resources: undiscovered materials reasonably
expected to exist in a known
mining district under known geological conditions.
b.Speculative resources: undiscovered materials that may occur in
either known types of deposits in favorable geological settings
where no discoveries have been made, or in yet unknown types of
deposits that remain to be recognized.
IV. on the basis of nature: resources may be classified as:
A. In organic resources- they include air water & ores.
B. Organic resources- they include plants, animals, fossils
fuels etc.
C. Inorganic + Organic- e.g. soils
V. On the basis of ownership
A.Individual Resources: resources owned privately by individuals.
E.g. farm land owned by farmers.
B.Community Owned Resources: resources available to all
the members of the community. For
example the village common land for grazing, village ponds,
public parks, playgrounds .
C.National Resources: All the minerals, water resources, forests,
wildlife, land within the political boundaries and oceanic area up to
12 nautical miles (19.2 km) from the coast are included in
national resources.
D.International Resources :The oceanic resources outside of the
Exclusive Economic Zone (the area up to 200 nm ((370 km) from
the coast line in which the country has the exclusive rights to
exploit the natural resources).
Value of natural Resources
Resources are undoubtedly the back bone of our civilization.
Resources are those stocks used by people to meet predefined
needs.
They form the basis for the material and spiritual satisfaction of
human requirements.
Some are directly consumed (e.g. fresh-caught fish, water, hunted game) or
consumed in production process (e.g. coal burned to produce electricity) and
others are used in production of new materials (Raw materials are embodied
in final product e.g. iron ore becomes steel for car body). Natural resources
are also used in-situ (parks, wilderness areas, resorts).
The diverse uses of resources can be grouped in to three general values.
A. Economic values
Have actual and potential economic value.
As source of sustainable food and clothing.
Providing constructional and building materials that are useful in
the
economic system of any society.

B. Cultural values - The cultural importance of natural resources is reflected in the;
 Aesthetic and recreational values:- Outdoor recreational activities- Have become
useful for mental and physical refreshment and recreations, providing attractive
scenery, beautiful wilderness, fresh air etc, and are useful in promoting the
tourism industry.
 Educational and scientific values- the resources and its ecosystem are useful
sources of information and knowledge in the fields of science, medicine, space
research and innovation. E.g. plants or their extract are a source of medicine.
C. Ecological values
Ecology is the relationship of all living things with their environment.
The use of one resource in an ecosystem may have an effect on most of the other
resources.
Factors affecting utilization of natural resources
Technological factor- knowledge, techniques and skills of harnessing resources,
to control and understanding of the material environment.
Economic factors- capital is an important input for the utilization of
resources
Political factors- government policies, civil wars may restrict exploitation
& exchange of resources
 What is
iteconomics?
is the social science that analyzes the production, distribution,
and consumption of goods and services.
 It deals with how scarce resources are allocated among
competing uses.
Natural resource economics: Natural resource economics is part
of economics which focuses on:
 supply Vs demand ,
 Allocation
 An optimal use of Earth's natural resources.
It is the study of how economic and natural systems interact in
order to develop an efficient economy.
 Natural resource economics addresses the connections and
interdependence
Natural Resources Economics
Study how society allocate natural resources over time
under different market setting
 It is about problems natural resources management
- inter temporal in nature
-deal with different types of
resource Environmental Economics
Deal with economic analysis of proble
environmental
(pollution, global warming etc…) ms
 It undertakes theoretical or empirical studies of the economic
effects of national or international environmental policies around
the world.
 It study alternative environmental policies to deal with pollution,
water quality, toxic substances, solid waste, and global warming
 It study about environmental problems & policy
 The focus is how to operate an economy within the
ecological constraints of the earth's natural resources.
 Environmental Economics: It is part of economics which
concerned with the valuation of the natural resources.
 Environmental economics answer three broad questions.
i. What are the economic and institutional causes of
environmental problems?
How do the economic and social systems shape incentives in ways
that lead to environmental degradation as well as to improvements?
ii. How can we assess the economic importance ?
Monetary value of environmental degradation and improvements?
iii. How can we design economic incentives ?
To slow or halt environmental degradation and bring
about improvements in the quality of the natural
environment?
 The first question leads to an analysis of market failure
and
government failure.
 For example,one of the principal reasons for market failure is that there are
incomplete markets for environmental assets.
 By incomplete we mean there are many cases where no market exists
for the efficient allocation of an environmental resource.
 There are plenty of examples of where markets are
incomplete including:
 Clean air
 Beautiful views
 Unpolluted beaches
Tropical rainforests, with their biodiversity and their carbon-
fixing properties
 A quiet environment
 Therefore it is important to employ scarce resources efficiently by
considering environment in economic calculations
 The second question requires that we are able to place economic
values on environmental degradation and
improvements. As we have already noted, many environmental
resources and goods are not priced in markets.
 Thus,to do this,environmental economics has developed a set
ofmethods to place values on these types of goods.
 To address the third question we will use economic tools to
critically evaluate environmental policies and whether they are
likely to achieve the aims of decreasing or halting environmental
degradation.
 Society and the economy are subsets of
the
environment.
 It is not possible for social and
economic systems to exist
independently from the environment.
Natural resource economics focuses on the demand, supply, and allocation
of natural resources to increase sustainability.
Scarcity
 The limitation in the supply of items or a commodity relative to the
need for it/demand.
 It is economic problem of having seemingly unlimited human wants in a
world of limited resources.
 It is a universal problem that face all societies,because there are not enough
resources to produce everything people wants.
 Scarcity exists in all countries with out regarding to their level of
economic development.
 Scarcity leads to choice in resource allocation(What,how & for
whom to produce)
 When we make a choice from different alternatives,choice of one thing
means scarify/forgone/loss/given up of other things.
 What is the tradeoff of that choice? Opportunity cost.
 Opportunity cost:-the amount of other commodities that
must be forgone/satisfy in order to produce the first.
 When something scarce,it is allocated to only one particular
use,
the
opportunity cost of that choice is the value of the best
alternative given up
Opc= the amount of the next best alternatives given up
The amount of commodities produced
 Simple E.g. Assume a given resources used for production of
12units of clothes and 48units of bread then find opc of both
commodities?
Sol'n
opc of cloth= given up good/ produced good
=48/12
=4units of
bread Opc of bread=given up
 The concepts of scarcity and opportunity cost can be
illustrated in
a and
production possibilities
that can be produced in afrontier (PPF).
given time period when available clothing
 The following
resources arePPF
fullyrepresents all theemployed.
and efficiently possible combinations of food
 Point B & D on the curve shows the production
possibility of two products.At these points there are a ful
utilization of resources which is attainable and efficient.
 point “A" that is inside the production possibility frontier.It
shows inefficient utilization of resources
(attainable but inefficient).Because there are idle
resources,which are not used
 point “C" outside
for production.It can
thebeproduction
expanded up to thecurve.
frontie
which represents unattainable
possibility r
combinations of goods at current condition of
resources and
1. Natural Resource vs. Environmental Economics
 What is economic rationality? A choice from among
competing options is said to be economically rational when
it yields anticipated net benefits that exceed the
opportunity cost.
What is natural resource economics?
 is the study of how to best govern scarce natural resources,
especialy, those such as air,ground water, marine fishery that
are common rather than private properties.
 The sort of questions and problems to be studied in the
area of natural resources economics are:
Production, markets,management, uses,and abuses of natural
resources such as fisheries, forests,and non renewable
resources extraction
What is environmental
economics?
 Is the study of the impact of the goods andservices
produced by economy,particularly market
systems of allocation,on environmental
quality and
ecological integrity?
 The sorts of questions and to be
studied under environmental
economics are:
Economics of pollution,causes,targets and instruments
for their control,and environmental
valuation.
 1.2. Basic Issue In Natural Resource &Environmental
Economics The Three Themes
Three important themes of natural resources economics :
Efficiency, Optimality and Sustainability
I. Efficiency
 An organization of production and consumption
unambiguous
such possibilities for economic well-
increasing
that al been exhausted. being have
 The state of being efficient
 Eliminating waste /inefficiency=>increase net benefit. Two types
 Technical or physical efficiency:Maximal output given input
levels
Allocative or pricing efficiency:Right mix of inputs given
their prices
Optimality

: An of suc that no
reallocation is possible
allocation which would
resources h provide gains in
further
production or consumer satisfaction to some firms
or individuals without simultaneously imposing losses on
others.
It is related to efficiency but conceptually
distinct. Optimality needs:
 A relevant group of people/society
 Overall objective of the society
It is the resource use decision desirable from
that society’s point of view?
 Optimality can be expressed simply on attainment of;
 Economic efficiency in production of goods and services;
 Economic efficiency in distribution of goods and services;
 Resource allocation consistent with consumer preferences.
 Efficiency is a necessary but not a
sufficient condition for optimality;
 Resource allocation cannot be optimal unless it is
efficient.
 optimality includes equity
 However,efficiency is not a
sufficient condition for optimality;
 In other words,even if a resource allocation is efficient, it may not
be socially optimal.
 This arises because there will almost always be a multiplicity of
different efficient resource allocations, but only one of those will
 Sustainability
: taking care of posterity (all future generations of people) or
 It

taking care of intergenerational equity.

Q. If an allocation of resources is socially optimal,is it true that it is
also sustainable? May be Yes or No
 If sustainability matters,then it would enter into the list
of society’s
objectives and be taken care of in achieving optimality.
 Not quite so straight forward.
 Optimality in economics will not necessarily take adequate
care of posterity/ all future generation/
 1.3.Emergence of Natural Resource
and Environmental
Economics
I. Classical economists
Adam Smith (1723-1790) was the first writer on importance
of markets in allocating resources. In his book “the nature
and causes of the wealth of nation” (1776) contains the
famous statement of the role of the ‘invisible hand’.
 When people pursue economic self-interest
in a competitive market place;
The market is guided by an“invisible hand” no need
of gov’t or external body involvement/.Only by
demand and supply
Society benefits
Thomas Malthus (1766- 1834) in his essay on the
principle of population (1798), raised the question of the
continuity of long run economic growth as“neo-
Malthusian”.
 For Malthus,the fixed land quantity and continual positive
population growth and diminishing
returns in agriculture lead to output per capita
to fall over time.
 If those the long run tendency for the living
standards of the mass of people to drove down to a
subsistence level, steady state or subsistent level of
living standards.
David Ricardo (1772-1823) in his principles of political
economy and taxation (1817) extended the concept of
steady state.
 He replaced the assumption of a fixed stock of land
by land was available in parcels of different
quality.
 Agricultural output could be expanded by:-
Increasing the intensive margin (exploiting a given
parcel of land more intensively) or
Increasing the extensive margin
(bringing previously uncultivated land into
John Stuart Mill (1806-1873),in particular (1857) one finds
a ful statement of classical Economics at its conclusion.
 His work utilizes the idea of diminishing return, but
recognizes the knowledge of technical progress in
agriculture and in production more generally.
II.Neoclassical Economics
 Neoclassical economics includes
psychology ;What psychological factors underlie
consumer choices?
 Market prices reflect supply vs. demand .Buyers
vs. sellers
 The “right” quantities of a product are
produced;“Optimal” levels of pollution, resource
 1.4. Ecological
Economics
 Study about the physical, biological and social structural and functional
relations
b/n economies and natural ecosystem
 theinterdependence and coevolution of human economies and
natural ecosystems over time and space
 Treat the economy as a subsystem of the ecosystem and emphasis preserving
natural capital
 It uses principles from the natural sciences (particularly thermodynamics
and
ecology) to study the joint economy-environment system
Physical and Natural Environment

Social System

Economic
System
 1.5.Approach to Resource and Environmental
Issues right, Efficiency and Government Intervention
1.Property
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.
If property rights do not exist, or are notclearly 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, this implies the need for government policy
intervention to seek efficiency gains.
 Deciding ;
where a case for intervention exists,and
what form it should take, are central in al of resource and
environmental economics.
 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.
 An externality existswhere a consumption
or production activity has unintended
effects on others for which no compensation
⚫ Here, the external effect is an untraded–and un priced–
product arising because the victim has no property rights
that can be exploited to obtain compensation for the external
effect.
⚫ However, the absence of a price for a resource an
or external effect does not mean that it val
⚫ has no if well-being is affected, there is a value thatue.
Clearly, 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.
 1.6 .TheTime Dimension
Economic Decision
⚫ Natural resource stocks can be classified in various ways.
 Stock resources
Flow
resources Stock resources
 Resources that have the characteristic that today’s use has implications
for tomorrow’s availability E.g.plant and animal populations and
mineral deposits
Flow resources
 Resources that have the characteristic that today’s use does not itself
have any implications for the availability of tomorrow. E.g.solar
radiation,and the power of the wind,of tides and of flowing water.
 Stock resources can be categorized
under
Renewable Resources
Nonrenewable Resources.

Renewable
Resources that have capacity
resources grow size over time,
through
to biological in plan and
populatio
reproduction. E.g. t animal
 Renewable
ns, resources are also exhaustible biotic,
harvested for too long at a
if exceeding their regeneration rate
capacities.
Non-renewable resources
 Resources that do not have that capacity to grow over time.
E.g.abiotic,stocks of minerals.
 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.
 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.
Substitutability and irreversibility
 Substitutability and irreversibility are important 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.
 On the other hand, if the resource is irreversible but has a close
substitute for its service, the sustainability of that resource needs less
concern.
Two main dimensions for sustainability issue are:
1) To what extent one natural resource can
be replaced by other.
E.g.can solar energy substitute fossil fuel at large
scale?
2) The degree to which an environmental resource can be
replaced by other inputs, especially human- made capital
resulting from saving and investment.
E.g.to what extent can an artificially produced oxygen
replace natural oxygen?