Economic and FinancialConcepts in Resource

Management

Last Lecture

Economic theory of natural or environmental resources utilizes several key concepts

a)consumption and demand,b) production and supply,c) market equilibrium and

d) present value.

Consumption and Demand TheoryHouseholds indirectly consume

natural and environmentalresources when they purchase a

house containing wood, plastic and

metal products and use

electricity, oil and natural gas to heat cool and light the house.

Households directly consume natural and environmental

resources when theybreathe air, drink water,

or use a forest for outdoor recreation.

The income that households use to purchase commodities

is earned by selling natural and human resources,

such as: land and labor to firms and the government..

Household savings are a source of capital that

firms and governments use to finance

production activities.

Consumption and demand theory explains

how an individual decides: what to consume,

how much to consume, and how consumption varies with commodity prices.

Natural Resources DecisionsResource management

refers to: the decisions made by: 1- resource owners ,

2 -managers Interest groups, and 3- policy-makers.

The four major paradigms,

or philosophical approaches ,to resource management

can be arranged in a decision hierarchy:

regarding the rate timing and method

of resource depletion, conservation and

management .

1-Circular Flow

2-Material Balances

4-Sustainable Development

3-Ecological Economics

Resource decision hierarchy

The circular flow model

This model concentrates on decisions that govern

the exchange of resources, such as: land, labor and

capital, between households and firms.

Resources management decisions in the circular flow model are governed by market prices that are determined by demandand supply conditions..

If the demand for a natural resource increases, then

market price increases until quantity demanded equals

quantity supplied

SPrice

Quantity

p1

q1

p2

q2

D1

D1

Not all resource decisions are subject to market forces .Water pollution by farmers

is not subject to market

forces because there is no market for clean water.

The second layer

The material balances model

Adds three new elements to the circular flow model::

1 -consumption of environmental services ,2 -disposal of material Energy residuals

And: 3 -assimilative capacity of the environment.

Most household, firm and government decisions related to

these elements are notgoverned by market forces .

For example:while there are markets for collection and

disposal of common household and business refuse, there are no markets, or

very limited markets, for disposal of

residuals in air and water bodies.

In the absence of a mechanism for keeping residuals below

assimilative capacities, air and water pollution is likely to

occur. The material balances model envisions direct public

intervention to reduce environmental pollution.

The ecological economics model and

the sustainable development mode:All four models consider economic efficiency

and equitable distribution of income:.

The material balances, ecological economics and sustainable

development models address the management of

environmental pollution.

Achieving an optimal scale for an economy relative to the ecosystem is a

unique concern of the ecological economics model..

The diversity and complexity of resource management

decisions, consequences of making wrong decisions and the likelihood of disagreement

and conflict increase moving from the bottom to the top layers

Sustainable development and ecological economics are placed in the same layer of

the decision hierarchy because they have many

common elements and their level of generality is comparable.

Both models focus on interdependencies

between

the economy and the ecosystem.

Sustainable development emphasizes conservationof natural resources and the environment as a means of

ensuring long-term economic development

Advocates of sustainable development support the short-term goal of economic growth, especially in developing countries, and the

importance of having developed

countries bear the burden of.

Reducing: environmental degradation

And: financing: environmental protection in developing countries

All four paradigms in the resource decision hierarchy are useful in understandingand resolving issues related to the development and/or

use of natural andenvironmental resources.

Types of ResourcesFirm and household

decisions regarding the use of natural and environmental resources are influenced by the physical and biological

attributes of a resource.

Trees and fish have different physical and biological attributesthan do petroleum and minerals.

These differences have important economic implications for the

spatial and temporal use and

management of natural and environmental resources

Natural and environmental resources

can be classified into two broad categories:

- exhaustible resources and: - renewable resources

Exhaustible resourcesThe stock of exhaustible resources

Such as: petroleum, coal and metals is fixed .

Use of exhaustible resourcesdepletes the current stock of the resource, which reduces its future

availability

The greater the rate ofuse, the more quickly the

resource is depletedA simple model can be used to illustrate the dynamics of exhaustible resources

Let So equal the initial stock of coal and Ut-1 equal the total use of coal used

through the end of period t-1..

The stock of coal available at the beginning of period t is determined

by the following stock equation:St=So - Ut-1

Suppose initial estimate of oil resources (So) is 600 billion barrels and cumulative use of oil through

the beginning of period t (Ut-1 is 300 billion barrels .

If current annual use of oil is 3 billion barrels, then current reserves and the number of

years of oil remaining at current use rates

)reserves-to-use ratio or R (are:St = 600 - 300 = 300 and

R = 300/3 = 100.

If St = 1,000 - 300 = 700 and R =700/3 =233

In this case, a 67 percent increase in oil resources results

in a 133 percent increasein the reserves-to-use ratio.

If oil prices decrease in response to the higher estimate of oil

resources, annual oil consumption could increase,

which would have the effect of lowering the reserves-to-use

ratio..

Physical exhaustion of a resource occurs when St = 0,

at which point the stockof coal is depleted.

Economic exhaustion of a resource occurs when the use of

the resource falls to zero..

Economic exhaustion usually occurs before physical exhaustionbecause extraction of a resource

will be discontinued when extraction is no longer profitable. Both concepts of exhaustion are

dynamic..

RENEWABLE RESOTIRCESSoil, water, crops, fish, wildlife,

forests and solar energy are renewable resources.

Unlike exhaustible resources, renewable resources are

regenerated through natural growth..

The time and space requirements for regeneration vary by resource.

Soil regeneration occurs at a relatively slow rate.

It takes decades, and in some cases centuries, to replenish the soil lost by high rates of water

and wind erosion.

There are many interconnections among renewable resources.

Crops require soil, water and sunlight (solar energy) for growth and development.

Forests contain trees, plants, fish and wildlife that require soil, water

and sunlight for regeneration..

Because of renewable resourcesdependence on complex physical,

biological and chemical processes, and the multiplicity of

uses, renewable resourcesare generally more difficult to

manage than exhaustible resources

Management of fish and animal populations is based on their age-sex structure, habitat and geographic distribution, all of

which are influenced by economic and environmental

conditions.

Consider a biological resource such as a forest The initial stock of the forest resource is called

biomass. Biomass at the beginning of

period t is:

St=So-Ht-1+Gt-1-Lt-1

where So is initial biomass, Ht-1 is cumulative harvest, Gt-1 is

cumulative biomass growth, and Lt-1 is cumulative biomass losses

due to natural causes such as fire and disease

A. subscript of t-l beside a variable

Designates the level of the variable as

of the end of period t-1.

Therefore, forest biomass:Decreases when Ht-1 > (Gt-1- Lt-1)

Increases when Ht-1 < (Gt-1- Lt-1) andremains constant when Ht-1 = (Gt-1- Lt-1) ,

where (Gt-1- Lt-1) is net growth in forest Biomass.

Water can be managed as a flow resource or a fund resource

It is a flow resource when the quantity available in a given period is not directly affected by human activities.A free-flowing river is a flow

resource.

If the river is dammed to create a water storage

reservoir, then the water becomes a fund resource.

Construction of the dam and reservoir allows the water to

be stored for later use..

The stock of water in the reservoir at the beginning of period t is:

S,=Ft-1-Wt-1-Lt-1Ft-1 is cumulative river flow into the reservoir

Wt-1 is cumulative withdrawals from the reservoir

Lt-1 is cumulative losses from the reservoir due to evaporation, seepage and other causes through

the end of period t-1.

Static EfficiencyEfficient resource use under pure competition

Consider how the efficient use of land is determined in a purely

competitive market..The demand curve for land is negativelysloped, which implies that the quantity

demanded of land decreases as theprice of land increases.

The market supply curve for land is represents the marginal

opportunity cost of land and the quantity of land.

The equilibrium price and quantity of land under pure

competition is illustrated in the next graph:

For the following market demand and supply curves:

Pd = 5O - 0.5Qd DemandPs = 5 + 0.5Qs Supply

Market equilibrium price is found by equating the demand and supply

prices and solving for Q:

50 - 0.5Qd = 5 + 0.5 Qs Qd = Qs50 - 5 = 0.5 Q + 0.5 Q

45 = Q Equilibrium quantity is Q = 45

From Pd= 50 - 0.5 (45) = 27.5From Ps = 5+ 0.5 (45) =27.5

Then: the equilibrium price is P=27.5.