Natural Resource and Energy Economics Chapter 17 In this chapter we start looking at the demand for natural resources, including energy, as the world’s population changes. First we will investigate the changes in the global population and what this might mean in terms of the availability of natural resources. In this analysis, resource consumption per capita is included. We will discuss the fact that economists don’t worry that the world will run out of energy and the alternative energies that might be available. Natural Resource and Energy Economics Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Resource Supplies: Doom or Boom? Population increased from 1 to 7 billion Standard of living is 12 times higher Consumption of resources is much higher Since the Industrial Revolution there have been historically high increases in population and the standard of living. The worldwide population has risen from 1 to 7 billion people, and the standard of living is now 12 times higher. With such a significant increase in the consumption of resources, the obvious question is whether or not our resources will be sufficient to sustain such large increases in the population and the consumption of resources. LO1

Population Growth Thomas Malthus (1798) predictions Replacement rate Total fertility rate Modernization Death rates fall Fertility rate falls below replacement rate In his 1798 An Essay on the Principle of Population Thomas Malthus predicted that increases in human living standards were only temporary because the higher standards of living would cause people to have more children. With a higher population, then living standards would fall. Total fertility rate is the average number of children that a woman is expected to have during her lifetime. Many nations have fertility rates below the replacement rate of 2.1. Demographers expect that the world population will reach a maximum of 9 billion before the population rate begins to fall. LO1

Total Fertility Rates, 2012 Country Total Fertility Rate Australia 1.77 Canada 1.59 China 1.55 France 2.08 Germany 1.41 Hong Kong 1.09 Italy 1.40 Japan 1.39 Russia 1.61 South Korea 1.23 Sweden 1.67 United States 2.06 This table shows many nations with fertility rates below the replacement rate of 2.1. Can governments raise birthrates? Proposed methods have not increased birthrates like second child bounties and increased child benefits. Possible future results might be too few young workers to support retirees and lack of soldiers. Source: The World Factbook, www.cia.gov. Data are 2012 estimates. LO1

Resource Consumption Per Person Increasing commodity demand Population growth Rising consumption per person Commodity supply has risen faster than demand Commodity prices are falling As recently as 1968, the theories of Malthus were still being discussed. Paul Ehrlich wrote The Population Bomb and predicted famines in the 1970s. No famines occurred and population growth slowed. The next slide provides evidence to explain the demise of dire predictions about the relationship between prosperity, population, and resource supplies. LO1

Resource Consumption Per Person This figure shows a commodity price index falling steadily since 1860. This fall in long-run real commodity prices provides evidence that over this period of 150 years, resource supply was able to grow faster than resource demand. Commodity prices show volatility but are much lower than they were in the past. Lower commodity prices imply that supply has increased more than the demand for commodities. As a result, the supply of commodities has risen fast enough to satisfy an increasing population and a huge rise in consumption per capita. LO1

Resource Consumption Per Person Will resource supplies be sustainable in the future? Prospects are hopeful Demand for resources will reach a peak and decline with falling birthrates Resource consumption per capita leveled off or is decreasing Studies indicate that resource supplies will be sufficient to sustain current standards of living. It is expected that demand for resources will reach a peak and then fall with the decline in the birthrate. Resource consumption per person has either remained constant or started decreasing. Both of these factors indicate that resource supplies will be sufficient to maintain the standard of living. LO1

Resource Consumption Per Person In this graph, we show the total demand for water and the per capita demand for water in the U.S. Demand for water (per capita water use) in the U.S. peaked in 1975 and then fell 28% before it leveled off. LO1

Resource Consumption Per Person Leveled off in the rich countries Demand will increase in poorer countries Challenge is to move resource supplies from their place of origin to places of need Resource consumption per capita has leveled off in the rich countries, but demand for resources will increase in poorer countries as they develop. This creates a challenge in moving the resources to the places where they are needed. If we are unable to move these resources to where they are needed, local shortages could develop in poor countries, even though there might be a surplus of the resource in other parts of the world where it is produced. LO1

Resource Consumption Per Person This graph shows the total and per capita energy use in the U.S. Per capita energy use peaked in 1979 and then leveled off. Total energy consumption between 1950 and 2008 nearly tripled, increasing from 34.6 quadrillion BTUs in 1950 to 97.3 quadrillion BTUs in 2011. Since 1990, total energy consumption has increased by an average of only 0.7 percent per year. LO1

Resource Consumption Per Person In this graph, we look at that total amount of trash created and the per capita trash in the U.S. Trash is studied to show the use of other resources by measuring the generation of solid waste. Per capita consumption of other resources has leveled off since 1990 at 4.7 pounds of trash per capita . LO1

Energy Economics This figure shows the inflation adjusted GDP per million BTUs of energy consumption in the U.S. from 1950 to 2011. It shows an increase in GDP per million BTUs of energy consumption over the period. Technological change increased the amount of goods and services produced, and the GDP per 1 million BTUs of energy rose from $57.90 in 1950 to $136.80 in 2011. Between 1988 and 2008, the U.S. produced 39% more goods per person with a constant amount of energy input per person. This is evidence of energy efficiency. LO2

Efficient Electricity Use The Challenge: Highly Variable Demand Variations in fixed costs Daily variations in demand Different types of generation technology One of the problems that energy companies face is the massive change in demand over a very short time period, like one day. Demand for energy is quite low at night while people are sleeping and then quickly begins to increase when people get up in the morning. It is a challenge for the electric companies to minimize their costs when demand varies so much, and many of the plants with the lowest operating costs have the highest fixed costs. To help adapt to this problem, electric companies use a mix of different types of generation technology. LO2

Efficient Energy Use Electric utilities firms use a mix of generation technologies and a variety of energy sources in 2012. This figure shows that half of the electricity is generated using large coal-fired plants and the rest comes from a variety of sources. LO2 Source: United States Energy Information Administration, www.eia.doe.gov.

Running Out of Energy? No likelihood of running out of energy Running out of cheap energy Multiple sources of supply Environmental impacts Economists don’t worry about running out of energy. There are many sources of energy, but the better question is: “At what price?” The price of alternative energies tends to be quite high, but prices will likely fall as the costs of producing these alternative energies fall. The pollution that is created from the generation of energy is not reflected in the price of energy. There are some sources of energy that are relatively clean and create little or no air pollution. However, their price does not reflect the much lower externalities associated with this kind of energy. If energy prices were high enough for “cheap” and dirty energy creation, the production of the energy could become cleaner as the higher price is sufficient for firms to make the energy generation clean. LO3

Running Out of Energy? LO3 The prices in this table are current alternative prices. As technologies improve the prices will fall, so the costs of replacing oil in the future will fall. Sources: Cambridge Energy Research Associates, www.cera.com; The Economist, April 22, 2006, www.economist.com. LO3

Natural Resource Economics Policies for extracting resources to maximize net benefits Present vs. future consumption Present value Renewables vs. Nonrenewables Renewable natural resources Nonrenewable natural resources Optimal management of natural resources requires incentive structures that consider net benefits today compared to net benefits made in the future. Present value is the measurement tool used to calculate the present-day value of a future amount of money. Using present value enables decision makers to use cost-benefit analysis when the costs and benefits occur at two different points in time. Understanding present value helps to ensure that resources are allocated in the best possible way. Renewable resources are resources that are capable of growing back if they are harvested at moderate rates. Renewable resources include things like forests, wildlife, oceans, etc. Nonrenewable resources either have a fixed supply or they take an extremely long time to renew themselves. LO4

Natural Resource Economics Optimal Resource Management Extraction strategy to maximize stream of profits User cost Sell today, cannot sell in the future Higher expected demand encourages less extraction today Property rights Nonrenewable resources include oil, coal, and metals. If the user of a resource chooses to extract the resource now, the user faces the opportunity cost of reduced future extraction – that is, not being able to extract that resource and sell it in the future. With nonrenewable resources, higher expected demand should encourage less extraction today. Property rights can be used to help guarantee that a firm will be able to profit by conserving the resources today. LO4

Natural Resource Economics TC = EC + UC EC Dollars B A P A firm has a two year lease on a mine. How much should it extract in each year to maximize profits? The firm should consider extraction costs (EC) and User Cost (UC). Even in year 1, the firm should calculate per unit profit as P – (EC + UC) or P-TC. In this figure the firm would produce Q1 in year 1 where EC + UC line crosses P at point B. At every point up to point B, the market price P exceeds the total cost. The output between Q1 and Q0 should be extracted in the second year because if you extracted this output in the first year, the first year profit would be less than the UC, the present value of the second-year profit . UC Q2 Q1 Q0 First-year quantity extracted LO4

Natural Resource Economics TC = EC + UC1 TC = EC + UC0 Dollars EC P The goal of profit maximizing extracting firms is to extract resources at a rate that will maximize their profits over time. If future demand rises, UC in the current period will rise to UC1 to reflect the increase in future profits, TC shifts up to reflect high UC and the amount of Year 1 consumption falls from Q0 to Q1. This conserves the resource for use in the future when it will be in higher demand. UC Q1 Q0 First-year quantity extracted LO4

Renewable Resources Elephant preservation Strong property rights Forest management Optimal forest harvesting Differences in property rights Variation in growth rates In the 1970s and 80s, the African elephant was on the verge of extinction due to illegal poaching for the ivory tusks. In some countries the elephant population had grown rapidly due to strong property rights. If forests are private property or strictly regulated by the government then there are incentives for sustainable harvests. If forests have no government enforcement or property rights there is an incentive for deforestation. LO5

Global Perspective This chart shows the percentage changes in the amount of land covered by forests. Large variation in growth rates is due to differences in property rights. LO5

Optimal Forest Harvesting Clear and enforceable property rights to a forest provide the incentive to manage forests on a sustainable basis and to reap long term benefits from conservation. The company plants an acre with seedlings and over time they grow slowly, then quickly slow down to zero growth. The company must decide when to harvest and when to replant. LO5

Renewable Resources Optimal fisheries management Difficult to assign property rights Policies to limit catch sizes Total allowable catch (TAC) Individual transfer quota (ITQs) It’s very difficult to assign property rights to fishing except by catching a live fish in the ocean which leads to overfishing. It’s always a race to catch the fish before someone else. Government often tries to impose policies to encourage sustainable catch, but often the side effects of these policies means that the catch ultimately isn’t limited. The total allowable catch (TAC) is one way to ensure that the number of fish caught is limited by setting a maximum total of fish allowed. However, the different fisheries still race to catch as many as possible before reaching the TAC. Government also imposes the issuance of individual transferable quotas, ITQs, which limit the number of fish each individual is able to catch. The quotas can be traded, and the race is eliminated since each individual is able to catch a certain amount. Market pressures cause the ITQs to be sold to fisherman who can catch the most fish efficiently. Society benefits. ITQs move production towards producers with the lowest cost. ITQs are only enforceable within 200 miles of the coast. The rest of the ocean is still a free for all! LO5

Renewable Resources Fishery Market Value of Catch Sea scallop $455,693,743 Lobster 399,476,190 Walleye pollock 282,399,223 Sockeye salmon 278,646,491 Pacific halibut 206,958,364 White shrimp 191,608,324 Blue crab 189,784,233 Pacific cod 146,940,754 Brown shrimp 144,592,574 Dungeness crab 140,443,133 This table identifies the top 10 U.S. fisheries in dollar terms. LO5

Renewable Resources LO5 A fishery collapse happens when the population is sent into a rapid decline due to overfishing. Fish are being harvested faster than they can reproduce. Maine red hake’s decline was abrupt. Atlantic tuna’s collapse was gradual. LO5

Is Economic Growth Bad for the Environment? Richer countries: Produce and consume more Spend more to maintain the environment Earn higher scores on measures of environmental quality (EPIs) Evidence indicates that richer countries spend more money to protect the environment. Essentially, protection of the environment is a normal good. As incomes rise due to economic growth, we would expect more environmental protections to be put in place. When countries are poor, they are much more concerned with getting out of poverty, and they are willing to sacrifice the environment to get out of poverty. The EPI compares countries based on how they are doing in terms of 25 environmental indicators including atmospheric carbon emissions, measures of air and water quality, the degree of wilderness protection, energy efficiency, and measures of whether a country’s fisheries and forests are being overexploited.