NATURAL RESOURCE AND

ENVIRONMENTAL ECONOMICS (NREE)

UNIT ONE
INTRODUCTION
 1.1 The subject matter of NREE
1.1.1 what NEE deals about
• Environmental stresses are now the crucial issues in all economic
systems, regardless of political ideology, from the very poorest to
the very rich.
• Humans actions are creating environmental problems like
deforestation/desertification, soil erosion, water and air pollution,
acid rain due to SO2 and NO, ozone depletion due to depleting
substances like CFCs, global warming due to CO2 and other gasses,
etc
• Thomas Malthus foresaw a time when the urge to reproduce would
create a situation in which population growth would outstrip the
growth of food supply, resulting in starvation and death.
• Modern ecologists have suggested that the environment possesses
a unique ‘‘carrying capacity’’ to support humans, and once that
capacity is exceeded widespread ecological disturbance occurs with
disastrous consequences for humanity
• Even if environmental problem is universal for all countries in the world, it
is much severe in poor countries.
 Poverty, which denies poor people the means to act in their own long-
term interest, creates environmental stress such as overgrazing of pasture
land, deforestation, extensive farming practices, etc.
 All these environmental problems give rise to the subject of natural
resource and environmental economics
 Environmental economics is concerned with the study of the impact of the
economy on the environment, the significance of the environment to the
economy and the appropriate way of regulating economic activity so that
balance is achieved among environmental, economic, and other social
goals.
 Natural resource economics, on the other hand, is concerned with
studying the production and efficient utilization of natural resources,
both renewable and exhaustible.
 Since both concern the natural world, we study them by combining
together as natural resource and environmental economics (NREE)
 1.1.2. A Brief History of the Subject
A. Early economic paradigms and the environment
1. The Classical economic paradigm
• Classical political economy stressed the power of the market to stimulate both growth
and innovation, but remained pessimistic about long-run growth prospects.
 Adam smith (1723-1790) argued that self interested rational behavior of individuals
could satisfy individual wants but also serve the interests of society as a whole through
the operation of freely competitive market.
 Governments were important only in the sense of providing ‘night watchman’ services,
i.e., to maintain law and order, national defense, and to provide other public goods
• Prominent classical economists such as Thomas Malthus (1766-1834) and David
Ricardo (1772-1823), were like Adam Smith, pessimistic about the prospects of long-
term economic growth.
 They expressed their ‘‘environmental limits thinking ’’ in terms of the limits on the
supply of good quality agricultural production.
 That means, since resources are scarce, the continuous rise in population growth
would result in the fall of per capita production
• Every one runs to maximize profit without taking care of the N&E assets. The invisible
principle means markets fail to allocate resources efficiently as there are market
failures as public goods, externalities and common properties for NRE assets. This
leads to distraction of most NRE assets that in turn result a limit to long-term
2. The Marxist Paradigm:
• Karl Marx (1818-1883) believed that progress was a process of natural
development.
• Progress in terms of material and technological advance made possible by the
exploitation (humanizing) of nature via science so that inherent value could be
turned in to use value.
• Marx emphasized the process of production and the fact that a reliable basis
for any society can only be provided if the system of production is capable of
reproducing itself, but it is very difficult to reproduce some natural and
environmental assets once they are used in the production process.
• This analysis gives us that natural systems could be a limit to reproduction:
what we call today a ‘‘material balance” approach to the process of production
over time.
• In terms of modern environmental issues this reproductive economic system
analysis raises questions about the sources and nature of technological
change.
• According to the Marxian view technological progress could increase
productivity and profit (in the capitalist system) but over the long run this
progress imposes a heavy cost burden on the environment as both the toxicity
 3.Neoclassical paradigm:
• The neo-classical (1870) introduced the marginal analysis and the equilibrium analysis.
• Neoclassical model has economic person, i.e., the economic (instrumental) value of
marketable commodities, un-priced environmental goods and services or consideration
for future generations is determined according to the amount of personal utility
yielded.
• The criterion of social desirability is usually expressed in terms of the so-called pareto-
criterion (welfare analysis).
• The basic theorem of welfare economics seeks to legitimize rational behavior as being
socially desirable and also to justify some government intervention(because of market
failure)
• The basic neoclassical view sees government as an essentially ethical agent only
intervening in the market to ease the tension between individual rationality and
collective ethics.
• Ethical or moral obligations are not recognized at the level of the individual. So that, this
paradigm supports the intervention of government into the economy to maximize
social welfare.
• This means that there must be a certain body or party that protects natural resources
and the environment since healthy and protected environmental assets will improve the
welfare of the society.
 Bottom line: the classical and Marxian early economic paradigms were pessimist about
the future, but according to the neoclassical paradigm, government intervention can
B. Post-war economics and the rise of environmentalism
• During the 1960, environmental pollution intensified and become
more widespread.
• Environmental awareness was consequently sensitive and gave rise
to the new environmental ideologies.
• Economists continued to argue that economic growth remained
both feasible (a growing economy need not run out of natural
resources) and desirable (economic growth need not reduce the
overall quality of life). What was required, however, was an
efficiently functioning price system.
• Since 1970 a number of “world views” has crystallized within
environmentalism, providing the background to the emerging
environmental economics sub-discipline.
 The basic views distinguished includes:
 support for market and technology-driven growth process which is
environmentally damaging
 a position favoring managed resource conservation and growth
 “eco-preservationists” positions which explicitly reject economic growth.
 1.2 Inter-linkages between the Environment and the Economy

• The inter-linkage between the economy and the

environment is summarized in the following figure.
• Two sectors economy: production and consumption. The environment is shown in
two ways: as the three interlinked circles E1, E2 and E3, and the all-encompassing
boundary labeled E4.
• The production sector extracts energy resources (such as oil) and material resources
(such as iron ore) from the environment.
• Energy and materials (E1) are transformed into outputs (goods and services) in the
production sector and consumed by consumers.
• There are waste products, such as Co2 or So2 from these two sectors and are
disposed into the environment (E2).
• These wastes pollute the environment and human wellbeing is affected through the
reduction of amenity (E3).
 From the above diagram we can see that the environment is used as supplier of
resources (E1), as a sink or receptor for waste products (E2) and amenity or spiritual
values (E3).
• There is some recycling of resources within the production sector as shown by the
circle R1, and circle R2 in consumption.
• The diagram shows that using the environment for one purpose (extracting energy
and material sources) can reduce its ability to supply us with other services (amenity,
e.g. clear air).i.e., (E1, E2, and E3) are overlapped each other.
• There are conflicts in resource use. The environment is thus a scarce
resource. Economics has a role to play in allocating scarce resources among
conflicting uses.
• In allocating resources efficiently, price signals are very important. But the
problem is most environmental goods have not market prices.
• Returning to the diagram, the boundary marked E 4 represents the global
life-support services provided by the environment. These include the
atmosphere, the temperature, climate, etc.
• These components that are suitable for life are affected by the wastes from
the production and consumption sectors(dashed line between E 2 and E4)
• In some cases, wastes are biologically and/or chemically processed by the
environment.
• For example, organic emissions (wastes) are broken down by natural
processes-the action of micro-organisms into their chemical component
parts which can be harmful or not.
• There are also wastes that can not be decomposed or can not be broken
down by natural processes. Such wastes are termed as “cumulative” and
“conservative” pollutants e.g., DDT.
=
• For degradable pollutants, such as organic effluents
(from brewing or paper production, and methane) the
stock in any time period t is given by:
Sat = Ft – At
Where; Sat = Stock in any time period of assimilative wastes. F t
= flows of wastes and At = the amount of wastes at time t that
are removed by chemical reactions or degradation
• For cumulative pollutants (wastes), the stock in any
period t* is:
t*

where ti = date when emissions

F
c
St = t
ti

began and A= 0.
• According to neoclassical economics, social well-being is the sum total of
individual well-being and this individual well-being is measured by the utility
derived from various goods and services:
UA = U (X1, X2,…Xn; Q1,Q2,….Qm)
where; UA = utility of individual A. X1...Xn are Goods and services
produced in the production sector.Q1...Qn are environmental assets, such
as air quality, water quality, etc
• The environment supplies utility directly to A via the vector of environmental
assets, and indirectly via its roles in the production of the vector of goods and
services (X1,… Xn). Clearly an increment in the vector of (X1,…Xn) will decrease the
quantity or quality of the vector Q.
• For example, X1 can be a car;
 The increase in the production of car will decrease the quality of the stock iron
ore and reduce the quality of air or water (Q1) through pollution.
 An increase in the consumption of car services increases utility by (dU A/dX1 which
is positive), but this action decreases air quality by (dQ 1/dX1 which is negative).
 This fall in air quality reduces utility in an amount
(dUA/dQ1) (dQ1/dX1) < 0.
(+) (-)
• From the pervious diagram, we may ask whether the inter-linkages
are governed by any systematic physical processes or natural laws.
In this environmental analysis there are two important physical
laws. These laws are:
 The first law of Thermodynamics
 The law of Entropy
• Both laws hold true in strictly closed systems, systems with no
external inputs (i.e., a system that does not exchange matter or
energy with its environment.)
• The first law of Thermodynamics states that matter, like energy, can
neither be created nor be destroyed. This law also known as the
materials balance principle.
• The second law (law of entropy) states entropy exist which means in
the production process there is a must for wastes to exist.
– E.g., The extraction of resources (R) creates waste, such as mining of iron
ore, production (P) such as car, creates waste in the form of industrial
effluent , air pollution; final consumers (C) create waste by generating
sewage, litter, and municipal refuse.
• The amount of total waste (W) in any period is equal to
the amount of natural resources (R) used up. That is R =
W = WR +Wp+ WC. Where WR, Wp and Wc represent
wastes from extracting raw resources (R), production of
goods and services (P) and consumption (P) respectively.
• The reason for this equivalence is the first law of
Thermodynamics.
• Considering this circular economy (diagram ), a closed
system sets limits, or boundaries to achieve utility. This is
because, as we discussed earlier, not all wastes are
recycled.
• A great deal of waste is not recycled, but simply goes
into the environment (pollution). Why is not all waste
recycled? It is here that the second law becomes relevant.
That is the entropy law. Consider the following diagram.
• Letters R, P, and C are as defined in the
previous diagram. W and r represent
wastes and recycling respectively.

•The materials that get used in the

economy tend to be used entropically-they
get dissipated within the economic system.
• E.g., Of the many hundreds of
components in a car it is possible to
recycle (r) only a few of them-may be
the aluminum in some parts, lead
from the batteries, and steel in the
car body. But plastics can not be
recycled (not feasible). Energy
resources can not be recycled.
• Entropy therefore places a physical obstacle, another “boundary”, in the
way of redesigning the economy as a closed and sustainable system. Those
wastes (W) that can not be recycled will go into the environment.
• So long as we dispose of waste in quantities (and qualities) that are
proportionate with the environment’s assimilative capacity, the circular
economic system will function just like a natural system.
• But if we dispose of wastes in such a way that we damage the capability of
the natural environment to absorb waste, then the economic function of
the environment as waste sink will be damaged.
• Essentially, we will have converted what could have been a renewable
resource into an exhaustible one (e.g. high depletion of fish due to high
emission into water body).
• The assimilative capacity of the environment is thus a resource which is
finite. So long as we keep within its bounds, the environment will
assimilate waste and essentially return the waste to the economic system.
• The resource box, R, can be expanded into Exhaustible Resources (ER) like
coal, oil, minerals, etc and their growth rate g = 0; and Renewable
Resources (RR) have the capacity to renew themselves like forest, fish, etc
and their growth rate g > 0.
•In the case of RR, the stock of the
resource can increase (+) or decrease (-)
depending on the magnitudes of h
(harvest rate) and g (growth rate).

•If h<g the stock of the RR increases (+)

over time. But the ER is always
depleting because h>g, most of the
time. That means, h is positive implies
greater than zero.
•The inter-linkage between the economy
and the environment is obviously
closed and circular. The laws of
thermodynamics ensure that this must
be so.
• By looking at this circular flow (diagram
below), sometimes called a materials
balance model, we identify clearly three
economic functions of the environment:
As resource supplier,
As waste assimilator, and
As a direct source of utility (amenity)
• These three functions can also be regarded
as life support services
Where;
•  Flows of materials/energy
•  Utility flows
• R, P and C are defined as before.
• W is wastes from R, P and C
• U utility derived from C and
environmental amenity.
• A is assimilative capacity of the
environment
• Out of the total wastes (W) some are recycled (r) which
increases (+) the availability of resources (R) but much of the
wastes go to the environment.
• The assimilative capacity (A) of the environment is the
capacity of the environment to change wastes into some
harmless substances.
• If the disposal of wastes is excess than the assimilative
capacity of the environment (i.e., W>A) the service of the
environment as waste assimilator is eroded (damaged) so
that the R as well as U will be reduced (-).
• But if W<A, the resource (R) we have increases (+) as the
assimilative capacity of the environment is maintained and it
protects the depletion of the resource by wastes or
pollution.
1.3 The prospects: Two views- Limits to Growth Vs Optimist
View

A . The pessimist view or the limits to growth model

• Based on a technique known as systems dynamics, Professor Jay
Forrester predicted about the future outcomes of the world economy.
This pessimist model arrived at three main conclusions.
1. With in a time span of less than 100 years society will run out of the non-
renewable resources on which the industrial base depends. Then the result
will be the world economy will collapse and it shall be manifested by
massive unemployment, decreased food production, and a decline in
population as the death rate goes up.
2. Even if the resource base will be doubled, the economy will still collapse
due to excessive pollution generated by the increased pace of
industrialization permitted by the greater availability of resources.
3. Economic collapse may be avoided by an immediate limit on population
and pollution using self-restraint and conscious policy but it will finally end
up with societal collapse. Thus, one way or the other, economic growth will
cease.
• The dominant characteristic of the pessimist model is that the use
of resources (consumption) grows exponentially while most
resources are relatively fixed in quantity.
– Example: - A variable, say at present, is equal to 100 units (i.e., Year
1=100) and it grows at 10% every year means,
Year 2 = 110 (=100  10/100)
Year 3 = 121 (=110  10/100)
That means, for example, the current stock of a certain
resource is 100 units and if consumption of this resource is
growing at 2% per year, the stock will be exhausted in 55
years time. If we use 1 unit each year, at the end of the 1 st
year we will have (100-1 = 99). That is, we use the resource in
each year the following amounts.
Year 1 = 1 unit of the resource
Year 2 = 1.02 ” ”
Year 3 = 1.0404 ” ”
Year 4 = 1.061208 ” ”
B. The optimist view
• The final conclusion reached by this view is that a continuing evolution of
a form of technological progress that serves to push back the natural
limits until they are no longer limiting.
• Herman Kahn and his associates believed that technological progress
would be the solution for every problem of scarcity. That means the
sources of optimism are related to technological progress.
• The availability of physical resources can be expanded through the use of
better technology. For example, food production can be increased by the
spread of better farming techniques, if soils become depleted, then food
can be raised with hydroponics, a process using no soil, waste products
can also be converted into usable output using technological
advancement.
• The message of this model is that currently recognized technologies can
overcome the limitations envisioned by the limits to growth view. These
technologies effectively either remove the limit or buy time until a
subsequent technology can remove the limit. The saying “necessity is the
mother of invention” is the base for this optimist model.