Chapter One

Natural Resource and Environmental

Economics
 Chapter One
Introduction to Natural Resource and
Environmental Economics
Natural ressources versus environnemental ressource
A. Natural ressources : are resource provided by nature that
are divisible, i.e. they can be subdivided into smaller units.
Examples include ; a barrel of oil, a kg of gold, a ton of coal,
cubic meters of wood, kilograms of fish etc. And
We need to use other inputs, like labour, capital and energy
to utilize these resources
They are broadly classified into two: renewable and non-
renewable resources
A. Renewable resources

• These resources have a regeneration capability. They can

be replenished naturally.
• Examples: fish, forests and other resources that can
renew or restock
• Stock of resource influences the growth or regeneration of
the resource stock.
• For example, the growth rate of fish stock depends on the size
of the stock
 B. Non-renewable resources

• Stocks of these resources are considered to be

fixed in supply.
• Rate of regeneration is so small relative to
consumption so that the stock can be regarded as fixed.
Examples include,
- Minerals: gold, aluminium, copper
- Energy resources: coal, oil, gas
Environmental resources
• These are resources provided by nature that are indivisible, i.e. cannot be
subdivided into smaller units
• Examples include an ecosystem, surrounding air (atmosphere), and the
ozone layer
• Ecosystem: all the animals and plants in a particular area, and the way in
which they are related to each other and their environment.
• Ozone layer: a layer of gases in the sky that prevents harmful radiation
from reaching the earth – prevents global warming and climate change.
Cont.
• Changes in these resources can be examined in terms of quality but not
quantity.
• These resources are not consumed directly but the services they provide.
→ Ecological Services – Services which flow from environmental
resources.
– Examples include clean air, clean water and fertile soil.
 The provision of ecological services depends on the quality of the
environmental resource.
Natural Resource and Environmental Economics

Economics
• The study of the allocation of scarce resources.
• Economics focuses on markets as a means to allocate
resources
Natural resource economics
• The study of how we manage natural resources to satisfy
human wants.
Cont.
 Environmental economics
• Application of economic analysis to environmental issues
such as pollution and the choice of policy instruments to
achieve environmental objectives.
• The study of economic agent’s [producers, consumers]
decisions that have environmental consequences and how to
affect these decisions to achieve environmental quality goals.
 Environmental and natural resource economics
• The application of the principles of economics to the study of
how environmental and natural resources are developed and
managed.
Why study natural resource & environmental
economics as a separate field?
There are issues special about resource and
environmental economics
1)Dynamics
- Natural resources often involve dynamic decisions,
i.e. time is an element in the decision.
- The decision to consume a good today typically does
not affect the ability to consume it tomorrow.
- However, the decision to use natural resources today
affects what will be available for tomorrow.
Cont.
Example: oil extraction from a fixed stock or reserve in
oil wells

• A decision of how much oil to extract this year affects

how much stock remains for extraction in future years.

• Therefore, decisions are not time independent in

natural resource economics.
2) Irreversibility
- Decisions on natural resources may have irreversible
consequences.
- Natural resources are vulnerable to irreversible action.
→ Irreversible Action - Action whose impact cannot be
reversed.
- Example is an action (such as over-fishing) which results in
the destruction of a fish species.
 Cont.
- Damage to natural resources due to irreversible action
has permanent or long-term effects.
- Once a fish species goes extinct, there will be no way
to retrieve the species.
- If a natural forest/national park is destroyed, future
generations would be unable to enjoy its beauty.
- This is not as large a problem for normal consumer
goods.
 3) Market failure
– In economics there is emphasis on perfectly
competitive markets.
– In perfectly competitive markets, prices reflect the relative
scarcity of goods and lead to efficient allocation of resources.
– However, the utilization of natural and environmental resources
is often characterized by market failure
– Marketes and prices often do not exist for natural and
environmental resources
Cont.
– Market failure is a common problem in natural resource
and environmental economics

→ Market Failure - situation in which an unregulated

competitive market is inefficient because prices fail to
provide proper signals to consumers and producers.

– When market failures exist, government intervention

may be appropriate
4) Inter-disciplinary approach

– Natural resource and environmental economics requires multi

disciplinary knowledge.
– Linkages between the economic and the natural environment.
– Joint importance of economics and other disciplines (e.g.
biological growth of resources).
• Need to know biological growth of fish or trees for harvesting
decisions.
Cont.
– When one thinks of utilization of fishery or timber forestry, it
becomes necessary to integrate the biological growth process of
fish or trees into the economic model, for making efficient
harvesting decisions.
Evolution of natural resource and environmental economics
• Natural resource and environmental economics is a
relatively new field of specialization in economics.

• Emergence of the field as a distinct/separate sub- discipline

is traced to the 1960s.

• Concerns with environmental degradation and limits to

growth due to resource scarcity encouraged the development
of the discipline since the 1960s.
Cont.
• However, natural resource use and environmental issues
have been an area of concern for economists since the birth
of modern economics in the eighteenth century.

• Foundations of natural resource and environmental

economics are found in the writings of the classical
economists
Classical economics
• Classical economics refers to economic thought/thinking in
the 18th and 19th century
• Classical economics was concerned with the effects of
population growth and land use on resource scarcity,
economic growth and standard of living (quality of life).
• The major question or interest of the classical economists was
what determined standards of living and economic growth ?.
• Classical economists considered land (natural resources) as
important determinant of national wealth and economic growth.
Classical economics (cont’d)
• Land (sometimes used to refer to natural resources in
general) was viewed as: – limited in its availability, as a
necessary input to production and that it exhibited diminishing
returns.
• They believed that the prospect for economic growth and
living standards in the long term for an economy is subject to
constraints on the supply of land.
• Classical economists making important contributions to the
subject include Adam Smith, Thomas Malthus, David
Ricardo, John Stuart Mill
 Adam Smith (1723-1790)
• His major work: An Inquiry into the Nature and Causes of
the Wealth of Nations (1776)
• He was the first to systematically argue the importance of
markets in allocating resources
– He made a distinction between the true value (natural price) of a
commodity and its market price
– He stated that the former is determined by the amount of labour in
the market while the latter is determined by the relative scarcity of
commodities in limited supply
– The natural price was a more relevant indicator of wealth than were
market prices
Adam Smith (cont’d)
• Smith introduced the notion of “the invisible hand”
– Smith states that Markets allocate resources efficiently through
the “invisible hand”
– Invisible hand is the un-observable market force that helps the
demand and supply of goods in a free market to reach equilibrium
automatically.
– Smith assumed an economy can work well in a free market scenario
where everyone will work for his/her own interest.
Cont.
“It is not from the benevolence of the butcher, the brewer, or
the baker, that we expect our dinner, but from their regard to
their own interest. We address ourselves, not to their humanity
but to their self-love, and never talk to them of our own
necessities but of their advantages.”

______ Adam Smith (1776)

Adam Smith (cont’d)
– According to Smith, in a free market no government
intervention is needed since the invisible hand guides
market participants to trade in the most mutually
beneficial manner.

– The invisible hand describes unintended social benefits

resulting from individual actions
Thomas Robert Malthus (1766-1834)
• His major works:
– An Essay on the Principle of population (1798)
– Principles of Political Economy (1820)
• Malthus assumed
– Land as a necessary input to production
– It is fixed in supply – it is limited in its availability
– There is diminishing return to land in agriculture
• Malthus argued population grows at geometric rate and
food supply (human subsistence) at an arithmetic rate
Malthus (cont’d)
– Output per capita falls over time
– Standard of living declines over time to a
subsistence level
 This declining human condition is referred to as the
Malthusian trap
• According to Malthus, population growth ultimately exceeds
the land’s potential to supply sufficient food, resulting in
starvation and death.
Malthus (cont’d)
• At the subsistence wage level:
– The living standards allow the population only to
reproduce itself and
– The economy would attain a steady state (a certain level) with a
constant population size and constant, subsistence-level, living
standards.
• In his view, the adjustment mechanism would involve rising death
rates caused by environmental constraints,
• The problem: Malthus ignored the impact of technology
– Technology increases the level of production from scarce resources
Malthus (cont’d)
Figure 1: The relationship between population and food-production
capacity
Malthus (cont’d)
• If population remains below the maximum food-production capacity of the land
(P<L*), there is sufficient food and per capita food consumption is maintained
• If population exceeds the maximum food-production capacity of land (P ˃L*),
– per capita food consumption decreases

– standard of living declines over time to a subsistence level

• Malthus concluded that population growth posed a trap for nations seeking to
develop.

• This condition is referred to as the Malthusian trap

David Ricardo (1772-1823)
• His major work:
Principles of Political Economy and Taxation
(1817)
• He replaced Malthus’ assumption of a fixed stock of land by a
conception in which land was available in different quality (i.e.
land is available in parcels of varying quality).
• According to David Ricardo, fertile land earns scarcity rent –
economic profit.
– Ricardo suggested that the price of land was determined by the
least fertile marginal unit of land.
– Since the price had to be sufficiently high to allow the poorer land
to be brought into production, more fertile land could be farmed at
an economic profit.
John Stuart Mill (1806-1873
• Mill believed economic growth was limited by
– The amount of land
– Diminishing marginal productivity of land
– Population growth caused by increased
industrial production
• Mill placed less emphasis on diminishing returns
• He recognized technological progress, and input substitution
(innovation) offsets diminishing returns to land and rapidly
increase agricultural productivity
 Cont.
• He is the earliest economist to address other values
associated with the environment
• In addition to agricultural and extractive uses of land, Mill
saw the environment as a source of amenity values
• Amenity values: recreational values such as the natural
beauty of countryside and provision of habitat for flora
and fauna
• The amenity values of the environment become of increasing relative
importance as material conditions improved.
1.2 Interlinkage between the environment and the
economy
• Economic activity depends upon and affects the natural
environment
Services that the environment provides
– Resource base : Provides raw materials and other inputs into
production processes: energy supplies, minerals, water, genetic
resources, etc.
– Amenity service base: The natural environment provides humans
with recreational facilities and other sources of pleasure. Example:
Swimming from an ocean beach, wilderness recreation, lying outdoors in
sunshine (sunbathe).
Cont.
– Waste sink
• Economic activity transforms raw materials into useful products
but in the process generates wastes
• We rely on the environment as a dump for our wastes (gaseous
emissions, liquid effluents, solid wastes)
• The environment has waste assimilative capacity and it
absorb, neutralize or recycle our wastes
– Life-support system
• Our natural environment provides natural and environmental
resources essential to life on earth. E.g. clean air, water,
conducive climate
The economy-environment relationship is conditioned by physical
laws.

• The first law of thermodynamics (law of conservation of

matter/ materials balance principle)
– energy and matter cannot be created or destroyed
• The law implies that the mass of materials flowing into the
economic system from the environment has either to
accumulate in the economic system or return to the
environment as waste.
– Mass of Material Inputs = Mass of Material Outputs + Mass of Waste/
Residuals
Cont.
If Mass of Waste > Assimilative Capacity → Pollution → Damages of
the Environment
– Excessive waste can depreciate the environment if it exceeds
the absorptive capacity of the environment
– Waste reduces the services the environment provides.
Example
– Air pollution causes respiratory problems;
– Water pollution may cause cancer.
Cont.
• The second law of thermodynamics (entropy law) - this law
states that entropy increases.
• Entropy is the amount of energy not available for work.
– The law implies that no conversion from one form of energy
to another is completely efficient and the consumption of
energy is an irreversible process.
– Some energy is always lost during conversion, and the rest,
once used, is no longer available for further work.
– The law also implies that in the absence of new energy inputs, any
closed system will eventually run out of energy.
– Since energy is necessary for life, life ceases when energy ceases.
The Economic System and the Environment
 1.3 Two views for the prospects of the environment
– Does the environment impose constraints on economic growth?
• Two views: Pessimist and optimist

A. The pessimist scenario (view) :this view is based on the conception that

i) Environmental resources are finite: our plant earth is a closed system

ii)The waste assimilation capacity of the environment is limited

- Therefore, according to this view, economic growth is ultimately

unsustainable, i.e. there are limits to economic growth
The limits to growth can arise from:
i) The depletion of non-renewable resources, or
ii) Excessive waste (pollution) generated by continued economic growth
(industrialization)
i) Limits due to the depletion of natural resources
–Economic growth → ↑rate of natural resource use
–Economic growth consumes successively larger amounts of natural resources
–∴Economic growth leads to the depletion of essential non-renewable natural
resources
Cont.
–Eventually, continuing economic growth becomes impossible
b/c the economic system (the industrial base depends on
nonrenewable (depletable) resources
–When resources are depleted the economic system collapses
•Massive unemployment, ↓ food production, ↓ population (↑
death rate).
Cont.
 ii) Limits due to pollution
 •What if the resource problem is solved by technological progress and
recycling?
 –Assume depletion of resources will not give rise to problems of
economic growth
 •The collapse of the economic system still occurs and economic growth
is eventually limited
 –This time economic growth is limited by excessive pollution resulting
from continued economic growth
 –Greater availability of natural resources → ↑Industrialization → ↑
pollution
Cont.
 –Given its limited waste assimilation capacity, the environment
will eventually be unable to absorb any more waste (pollution)
resulting from continued economic growth (industrialization)
 –This ultimately leads to ever-increasing environmental
degradation→ ↓ in the flows and qualities of environmental
services → the environment fails to sustain economic growth
 What if the resource depletion and pollution problems were somehow jointly solved?
 –population would grow unabated and the availability of food would become the binding
constraint.
 –Thus, the removal of one limit merely causes the system to bump into another one
The optimist scenario (view)
Is the pessimist view an accurate one? Optimists do not think
so
 The optimistic scenario acknowledges the fact of rising rates of
depletion of non-renewable resources and increasing flows of
environmental wastes.
 But optimists believe that markets can serve as regulators of resource
use to overcome both scarcities of resources and environmental
problems associated with economic activity
 They argue that markets respond to the depletable resource and
pollution problems in ways which eliminate or diminish their impact
CONCLUSION
 •In part the difference between the two views depends on how
human behavior is perceived.
 -If intensifying pressure on the environment results in a behavioral
response that further intensifies the pressures, pessimism is
justified.
 -If, on the other hand, the human responses are either currently
reducing those pressures or could be reformed so as to reduce those
pressures, the optimism may be justified
Thank You