11. Markets for Capital and Natural Resources Financial markets Natural Resource markets Financial markets Natural Resource markets

Financial Markets Demand for financial capital Supply of financial capital interest rate financial capital = loanable funds Demand for financial capital Supply of financial capital interest rate financial capital = loanable funds

Demand for Financial capital firms demand funds to finance capital purchases higher interest rate, more expensive to borrow –lower Q demanded of funds firms demand funds to finance capital purchases higher interest rate, more expensive to borrow –lower Q demanded of funds

interest rate Q funds D

Shifts in demand for funds population growth –increase demand for goods, –increase demand for capital, –increase demand for funds population growth –increase demand for goods, –increase demand for capital, –increase demand for funds

technology –increase demand for new capital, –increase demand for funds to finance it technology –increase demand for new capital, –increase demand for funds to finance it

Government borrowing –Federal gov’t deficits shift demand to the right Government borrowing –Federal gov’t deficits shift demand to the right

Supply of Financial capital people’s savings decisions –tradeoff between consuming today & consuming tomorrow Time preference higher interest rates –encourage saving –higher opportunity cost of current consumption –higher Q supplied of funds people’s savings decisions –tradeoff between consuming today & consuming tomorrow Time preference higher interest rates –encourage saving –higher opportunity cost of current consumption –higher Q supplied of funds

Shifts in supply of funds population –higher population, more saving –supply shifts right income –higher income, more savings –supply shifts right population –higher population, more saving –supply shifts right income –higher income, more savings –supply shifts right

expected future income –save today based on future needs -- retirement, college –save to smooth consumption over time –expect income to rise -- save less today, supply falls –expect income to fall -- save more today, supply rises expected future income –save today based on future needs -- retirement, college –save to smooth consumption over time –expect income to rise -- save less today, supply falls –expect income to fall -- save more today, supply rises

interest rate Q funds S D Financial market equilbrium i* Q*

Natural Resource markets renewable resources –land, forests, livestock nonrenewable resources –fossil fuels, metals renewable resources –land, forests, livestock nonrenewable resources –fossil fuels, metals

Market for land supply is fixed for type or location –perfectly inelastic supply is fixed for type or location –perfectly inelastic

S rent Q land D r* Q*

economic rent rent for land is special –land is available even if rent=0 –demand affects P, not Q economic rent –rent above what is required to induce Q supplied of factor rent for land is special –land is available even if rent=0 –demand affects P, not Q economic rent –rent above what is required to induce Q supplied of factor

S rent Q land D r* Q* economic rent

Pure economic rent –Income earned by resource with a perfectly inelastic supply Pure economic rent –Income earned by resource with a perfectly inelastic supply

Economic Rent amount of resource earnings ABOVE opportunity cost or resource earnings – minimum required earnings “gravy”! “bonus”! amount of resource earnings ABOVE opportunity cost or resource earnings – minimum required earnings “gravy”! “bonus”!

example: Shaquille O/Neal 2000: $35 million what is minimum for which he would play basketball and endorse stuff? –suppose $1 million economic rent: $34 million 2000: $35 million what is minimum for which he would play basketball and endorse stuff? –suppose $1 million economic rent: $34 million

when do resources earn rent? less elastic (more inelastic) the supply, –more rent as a % of total earnings less elastic (more inelastic) the supply, –more rent as a % of total earnings

Differential rent Rents earned to superior units of a resource –Where quality of resource affects productivity Examples –Highly fertile farmland –Highly skilled trial lawyer Rents earned to superior units of a resource –Where quality of resource affects productivity Examples –Highly fertile farmland –Highly skilled trial lawyer

Inframarginal rent Total rent when units of resource differ in their opportunity costs What causes differences? –Differences in objectives –Differences in constraints Total rent when units of resource differ in their opportunity costs What causes differences? –Differences in objectives –Differences in constraints

examplesexamples Nursing –Find the work rewarding –Other constraints in the job market Teaching summer school –Presence of small children –Children in college Nursing –Find the work rewarding –Other constraints in the job market Teaching summer school –Presence of small children –Children in college

Q res. P res. S D P* Q* upward-sloping supply earnings split rent opp. cost

Supply of nonrenewable resource at point in time Q is fixed but over time –use -- decrease supply –new discoveries -- increase supply –technology for better use -- decrease demand at point in time Q is fixed but over time –use -- decrease supply –new discoveries -- increase supply –technology for better use -- decrease demand

example: metals nonrenewable resource discover new sources use substitutes (plastic) Recycling technology nonrenewable resource discover new sources use substitutes (plastic) Recycling technology

Market-guided conservation Markets have built-in incentives for efficient resource use If a resource becomes scarce –Prices rise Copper is up 50% in 2006 Markets have built-in incentives for efficient resource use If a resource becomes scarce –Prices rise Copper is up 50% in 2006

If prices rise –People use less (conserve) –People substitute –Firms look for new sources –Firms look for alternatives If prices rise –People use less (conserve) –People substitute –Firms look for new sources –Firms look for alternatives

Problems with markets & nonrenewable resources Externalities –Extraction of oil, metals, natural gas have huge negative externalities –Market results in too much extraction Government policies –Major tax breaks to domestic energy producers Prices may not be sending the right signals Externalities –Extraction of oil, metals, natural gas have huge negative externalities –Market results in too much extraction Government policies –Major tax breaks to domestic energy producers Prices may not be sending the right signals

Doomsday scenarios Aka “We are running out of everything and we are all going to die” Aka “We are running out of everything and we are all going to die”

Paul Ehrlich The Population Bomb, 1968 "a major food shortage in the United States in the 1970s...hundreds of millions of people are going to starve to death." By 1999 U.S. population would be only 23 million (actual 1999 U.S. population = 288 million) "a major food shortage in the United States in the 1970s...hundreds of millions of people are going to starve to death." By 1999 U.S. population would be only 23 million (actual 1999 U.S. population = 288 million)

Limits to Growth 1974 World will run out of gold by 1981 mercury by 1985 tin by 1987 zinc by 1990 petroleum by 1992, and copper, lead, and natural gas by 1993 World will run out of gold by 1981 mercury by 1985 tin by 1987 zinc by 1990 petroleum by 1992, and copper, lead, and natural gas by 1993

An economist’s refutation: Julian Simon The Ultimate Resource (1983) Hoodwinking the Nation (1999) Doomsayers underestimate human ingenuity Julian Simon The Ultimate Resource (1983) Hoodwinking the Nation (1999) Doomsayers underestimate human ingenuity

Simon vs. Ehrlich Made a bet in 1980 for $1000 Simon bet price of 5 key metals would be LOWER in 1990 –Signaling less scarcity Simon won. Ehrlich paid –Simon offered to renew the bet, Ehrlich refused Made a bet in 1980 for $1000 Simon bet price of 5 key metals would be LOWER in 1990 –Signaling less scarcity Simon won. Ehrlich paid –Simon offered to renew the bet, Ehrlich refused

Real concerns about resources today: Has natural gas production peaked Will oil production soon peak? Has natural gas production peaked Will oil production soon peak? Hubbert’s curve

Are we running out of copper? Are we past the tipping point on global warming? BUT…. Doomsayers need to take some responsibility for lack of world action Are we running out of copper? Are we past the tipping point on global warming? BUT…. Doomsayers need to take some responsibility for lack of world action