Economic and Financial Concepts in Resource Management Last Lecture

Economic theory of natural or environmental resources utilizes several key concepts a)consumption and demand a)consumption and demand, b ) production and supply, c) market equilibrium and d) present value d) present value. Economic theory of natural or environmental resources utilizes several key concepts a)consumption and demand a)consumption and demand, b ) production and supply, c) market equilibrium and d) present value d) present value.

Consumption and Demand Theory Households indirectly consume natural and environmental resources 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. to heat cool and light the house. Households indirectly consume natural and environmental resources 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. to heat cool and light the house.

Households directly consume natural and environmental resources when they breathe air, drink water, or use a forest for outdoor recreation breathe air, drink water, or use a forest for outdoor recreation. Households directly consume natural and environmental resources when they breathe air, drink water, or use a forest for outdoor recreation breathe 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. natural and human resources, such as: land and labor to firms and the government.. 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. 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: how an individual decides: what to consume, what to consume, how much to consume, and how consumption varies with commodity prices. how much to consume, and how consumption varies with commodity prices. Consumption and demand theory explains how an individual decides: how an individual decides: what to consume, what to consume, how much to consume, and how consumption varies with commodity prices. how much to consume, and how consumption varies with commodity prices.

Natural Resources Decisions Resource management refers to: the decisions made by: 1- resource owners, 2- managers Interest groups, and 3- policy-makers. Resource 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 : 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 demand and supply conditions. and supply conditions.. Resources management decisions in the circular flow model are governed by market prices that are determined by demand and supply conditions. and supply conditions..

If the demand for a natural resource increases, then market price increases until quantity demanded equals quantity supplied If the demand for a natural resource increases, then market price increases until quantity demanded equals quantity supplied

S Price Quantity p1p1p1p1 q1q1q1q1 p2p2p2p2 q2q2q2q2 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. 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 3- assimilative capacity of the environment. 1- consumption of environmental services, 2- disposal of material Energy residuals And : 3- assimilative capacity of the environment 3- assimilative capacity of the environment.

Most household, firm and government decisions related to these elements are not governed 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 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 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 The ecological economics model and the sustainable development mode: All four models consider economic efficiency and equitable distribution of income: and equitable distribution of income:. All four models consider economic efficiency and equitable distribution of income: 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. 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 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. 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 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. the ecosystem. Both models focus on interdependencies between the economy and the ecosystem. the ecosystem.

Sustainable development emphasizes conservation of 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 environmental degradation And: financing: environmental protection in developing countries Reducing: environmental degradation environmental degradation And: financing: environmental protection in developing countries

All four paradigms in the resource decision hierarchy are useful in understanding and resolving issues related to the development and/or use of natural and environmental resources. All four paradigms in the resource decision hierarchy are useful in understanding and resolving issues related to the development and/or use of natural and environmental resources.

Types of Resources Firm and household decisions regarding the use of natural and environmental resources are influenced by the physical and biological attributes of a resource. Firm 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 attributes than 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 : two broad categories : - exhaustible resources and: - renewable resources - exhaustible resources and: - renewable resources Natural and environmental resources can be classified into two broad categories : two broad categories : - exhaustible resources and: - renewable resources - exhaustible resources and: - renewable resources

Exhaustible resources The stock of exhaustible resources Such as: petroleum, coal and metals is fixed. and metals is fixed. Use of exhaustible resources depletes the current stock of the resource, which reduces its future availability

The greater the rate of use, the more quickly the resource is depleted A simple model can be used to illustrate the dynamics of exhaustible resources Let S o equal the initial stock of coal and U t-1 equal the total use of coal used through the end of period t-1. Let S o equal the initial stock of coal and U t-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 by the following stock equation: S t =S o - U t-1 Suppose initial estimate of oil resources (S o ) is 600 billion barrels and cumulative use of oil through the beginning of period t (U t-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 = = 300 and R = 300/3 = 100. 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 = = 300 and R = 300/3 = 100.

If St = 1, = 700 and If St = 1, = 700 and R =700/3 =233 R =700/3 =233 In this case, a 67 percent increase in oil resources results in a 133 percent increase in 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. 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 S t = 0, at which point the stock at which point the stock of coal is depleted. Economic exhaustion of a resource occurs when the use of the resource falls to zero. Economic exhaustion of a resource occurs when the use of the resource falls to zero.. Physical exhaustion of a resource occurs when S t = 0, at which point the stock at which point the stock of coal is depleted. Economic exhaustion of a resource occurs when the use of the resource falls to zero. Economic exhaustion of a resource occurs when the use of the resource falls to zero..

Economic exhaustion usually occurs before physical exhaustion because extraction of a resource will be discontinued when extraction is no longer profitable. Both concepts of exhaustion are dynamic. because extraction of a resource will be discontinued when extraction is no longer profitable. Both concepts of exhaustion are dynamic..

RENEWABLE RESOTIRCES Soil, water, crops, fish, wildlife, forests and solar energy are renewable resources. Unlike exhaustible resources, renewable resources are regenerated through natural growth. 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 rat e. Soil regeneration occurs at a relatively slow rat e. 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 Forests contain trees, plants, fish and wildlife that require soil, water and sunlight for regeneration..

Because of renewable resources dependence on complex physical, biological and chemical processes, and the multiplicity of uses, renewable resources are 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: Biomass at the beginning of period t is: S t =S o -H t-1 +G t-1 -L t-1

where S o is initial biomass, H t-1 is cumulative harvest, G t-1 is cumulative biomass growth, H t-1 is cumulative harvest, G t-1 is cumulative biomass growth, and L t-1 is cumulative biomass losses due to natural causes such as fire and disease and L t-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 H t-1 > (G t-1 - L t-1 ) Increases when H t-1 (G t-1 - L t-1 ) Increases when H t-1 < (G t-1 - L t-1 ) and remains constant when H t-1 = (G t-1 - L t-1 ) remains constant when H t-1 = (G t-1 - L t-1 ), where (G t-1 - L t-1 ) is net growth in forest Biomass. Water can be managed as a flow resource or a fund resource Therefore, forest biomass: Decreases when H t-1 > (G t-1 - L t-1 ) Increases when H t-1 (G t-1 - L t-1 ) Increases when H t-1 < (G t-1 - L t-1 ) and remains constant when H t-1 = (G t-1 - L t-1 ) remains constant when H t-1 = (G t-1 - L t-1 ), where (G t-1 - L t-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. 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. Construction of the dam and reservoir allows the water to be stored for later use.. 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. 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,=F t-1 -W t-1 -L t-1 F t-1 is cumulative river flow into the reservoir W t-1 is cumulative withdrawals from the reservoir L t-1 is cumulative losses from the reservoir due to evaporation, seepage and other causes through the end of period t-1. F t-1 is cumulative river flow into the reservoir W t-1 is cumulative withdrawals from the reservoir L t-1 is cumulative losses from the reservoir due to evaporation, seepage and other causes through the end of period t-1.

Static Efficiency Efficient resource use under pure competition Consider how the efficient use of land is determined in a purely competitive market. Consider how the efficient use of land is determined in a purely competitive market.. The demand curve for land is negatively sloped, which implies that the quantity demanded of land decreases as the price of land increases. The demand curve for land is negatively sloped, which implies that the quantity demanded of land decreases as the price of land increases.

The market supply curve for land is representsthe marginal opportunity cost of land and the quantity of land. 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 : The market supply curve for land is representsthe marginal opportunity cost of land and the quantity of land. 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 : P d = 5O - 0.5Q d Demand P s = Q s Supply Market equilibrium price is found by equating the demand and supply prices and solving for Q : For the following market demand and supply curves : P d = 5O - 0.5Q d Demand P s = Q s Supply Market equilibrium price is found by equating the demand and supply prices and solving for Q :

Q d = Q s Q d = Q s = 0.5 Q Q 45 = Q Equilibrium quantity is Q = 45 From P d = (45) = 27.5 From P s = (45) =27.5 Then: the equilibrium price is P=27.5 is P= Q d = Q s Q d = Q s = 0.5 Q Q 45 = Q Equilibrium quantity is Q = 45 From P d = (45) = 27.5 From P s = (45) =27.5 Then: the equilibrium price is P=27.5 is P=27.5.