Economics of Natural Resources

Unit 1:
1.1

Resource Taxonomy:

Natural resource management refers to the management of natural resource such as land, water,
soil, plants and animals with a particular focus on how management affects the quality of life for
both present and future generations. Natural resource management deals brings together land use
planning, water management, biodiversity conservation and the future sustainability of industries
like agriculture, mining, fishing, etc. The insights into sustainability provided by mainstream
economics are taken much further by environmental and ecological economists. The main areas
of contribution include the following:
1. A classification of sustainability views according to assumptions about the conservation
of natural resources.
2. Extending the analysis of externalities to provide a basis for designing antipollution
policies and deciding on the resources it is desirable to devote to avoiding pollution.
3. A range of methodologies for evaluating the services provided by environmental assets
and social capital to extend the inclusiveness of Cost Benefit Analysis.
4. Models for projecting the pricing and depletion of finite resources.
5. Assessments of the implications of various access regimes governing the harvesting of
renewable resources.
Natural resources are broadly classified under two categories:
1. Renewable and
2. Non- Renewable (depletable) Resources.
Renewable resources: Resources are renewable when they can be replenished after use and can
be sustained if natural flow of the resources is maintained. Renewable resources are generally
living resources (fish, coffee, and forests, for example), which can restock (renew).
Non- renewable natural resources: Non-renewable resources are those which remain on the
earth in different form after use and cannot be reconstituted in to their original form after use.
These resources, after use if not recycled properly become a waste material. Non-living
renewable natural resources include soil, as well as water, wind, tides and solar radiation, etc.
Discussion of resources and their use is important because in the pursuit of development
available resources are nearly over exploited. Therefore their efficient use and allocation is
highly significant for attaining sustainable development.

However, understanding the conditions of efficient allocation of both the types of resources
requires understanding of resource taxonomy and the distinction between categories of1
resources - depletable and renewable and issues emerging from these distinction.
Resources can also be classified on the basis of their origin i.e. biotic and abiotic.
Biotic resources: Biotic resources are derived from animals and plants (i.e.-the living world).
Biotic is a living component of a community; for example organisms, such as plants and animals.
Abiotic resources: Abiotic resources are derived from the non-living world e.g. land, water, and
air. Mineral and power resources are also abiotic resources some are derived from nature. In
biology and ecology. Abiotic resources are non-living chemical and physical factors in the
environment which affect ecosystems.
Water resource: Water resources are usually renewable resources which naturally recharge.
Overexploitation occurs if a water resource is extracted at a rate that exceeds the recharge rate,
that is, at a rate that exceeds the practical sustained yield.
Forest resources: Forest is overexploited when they are logged at a rate faster than reforestation
takes place. Reforestation competes with other land uses such as food production, livestock
grazing, and living space for further economic growth.
Deforestation: Deforestation is the removal of a forest or stand of trees where the land is
thereafter converted to a non-forest use. Examples of deforestation include conversion of
forestland to farms, ranches, or urban use. The term deforestation is often misused to describe
any activity where all trees in an area are removed. However in temperate climates, the removal
of all trees in an areain conformance with sustainable forestry practicesis correctly
described as regeneration harvest. In temperate climates, natural regeneration of forest stands
often will not occur in the absence of disturbance, whether natural or anthropogenic.
Furthermore, biodiversity after regeneration harvest often mimics that found after natural
disturbance, including biodiversity loss after naturally occurring rainforest destruction.
Resources characteristics: Resources have three main characteristics namely
1.
Utility,
2.
Limited availability and
3.
Potential for depletion or consumption.
Utility: In economics, utility is a measure of satisfaction, referring to the total satisfaction
received by a consumer from consuming a good or service.
Limited Availability or Scarcity: Scarcity is the fundamental economic problem of having
humans who have unlimited wants and needs in a world of limited resources. It states that
society has insufficient productive resources to fulfill all human wants and needs.

Resource depletion: Resource depletion is an economic term referring to the exhaustion of raw
materials within a region. Resource depletion is most commonly used in reference to farming,
fishing, mining, and fossil fuels.
Causes of resource depletion:
A.
B.
C.
D.
E.
F.
G.
H.
I.
J.
K.

Over-consumption/excessive or unnecessary use of resources

Non-equitable distribution of resources
Overpopulation
Slash and burn agricultural practices, currently occurring in many developing countries
Technological and industrial development
Erosion
Irrigation
Mining for oil and minerals
Aquifer depletion
Forestry
Pollution or contamination of resources

Three separate concepts are used to classify the stock of depletable resources which is based on
the stage of development of natural resources.
1.
2.
3.

Current reserves
Potential reserves and
Resource endowment.

Current or Actual reserves are defined as known resources that can profitably be extracted at
current prices and can be expressed as a number. Current resources are those that have been
surveyed, their quantity and quality determined, and are being used in present times. For
example, petroleum and natural gas is actively being obtained from the Mumbai High Fields.
That part of the actual resource that can be developed profitably with available technology is
called a reserve resource, while that part that cannot be developed profitably because of lack of
technology is called a stock resource.
54
Potential reserves are resources that can be extracted at the prices people are willing to pay for
these resources the higher the price higher is the potential reserves. Potential Resources are
known to exist and may be used in the future. For example, petroleum may exist in many parts of
India and Kuwait that have sedimentary rocks, but until the time it is actually drilled out and put
into use, it remains a potential resource.
Resource endowment represents the natural occurrence of resources in the earths crust and
independent of prices. This concept is more geological rather than the economic.

Total Resources
Identified
Demonstrated
Indicated

Measured

Hypothetical

Speculative

Reserves

marginal Sub- Para-marginal

Sub-Economic

Economic

Measured

Undiscovered

Fig: 1 McKelvey Diagram of Resource Stock or Categorization of Resources

The US Geological Survey (USGS) has developed a classification system of resources illustrated
in figure-1, which has two dimensions - economic and ecological.
Movement, in the figure 1 from top to bottom represents movement from cheaply extractable
resources to those extracted at substantially higher prices. By contrast, a movement from left to
right represents increasing geological uncertainty about the size of the resource base.
This concept is important because it places an upper limit on the availability of terrestrial
resources.
Terms of McKelvey Diagram of Resource Stock:
Identified resources: specific bodies of mineral bearing material whose location, quality and
quantity are known from geological evidence and supported by engineering measurements.
Measured resources: material for which quantity and quality estimated are within a margin of
error less than 20 percent, from geologically well-known sample sites.

Indicated resources: material of which quantity and quality have been estimated partly from
sample analyses and partly from reasonable geological projections.
Undiscovered resources: unspecified bodies of mineral bearing material surmised to exist on
the basis of broad geological knowledge and theory.
Hypothetical resources: undiscovered materials reasonably expected to exist in a known
mining district under known geological conditions.
Speculative resources: undiscovered materials that may occur in either known types of deposits
in favorable geological settings where no discoveries have been made or in yet unknown types of
deposits that remain to be recognized.
Distinction between two categories of resources:
The first category of resources includes all depletable, recyclable resources, such as copper.
A depletable resource is one for which the natural replenishment feedback loop can be safely
ignored. The rate of replenishment of these resources is so low that it does not offer a potential
for augmenting the stock in any reasonable time frame.
A recyclable resource is one which although currently being used for some particular purpose,
exists in a form allowing its mass to be recovered once that purpose is no longer necessary or
desirable.
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The current reserves of depletable resource, recyclable resource can be augmented by economic
replenishment as well as by recycling.
Stimulant of Economic replenishment includes: price and technological progress. Another side of
the depletable resources is that their potential reserves can be exhausted owing to demand for
and durability of the products built with the resource.
62
In most of the cases the size of potential reserves of depletable resources depend explicitly on
our ability to store the resource. E.g. helium. Not all depletable resources permit recycling or
reuse such as coal, oil and gas which once combusted turns in to heat energy. The heat dissipated
in to the atmosphere and becomes non-recoverable. Even if most of them are recyclable (e.g.
copper) the theoretical upper limit on recycling is less than 100 percent.
Renewable Resources are differentiated from depletable resources primarily by the fact that
natural replenishment augments the flow of renewable resources at a non-negligible rate.
Examples include: solar energy, water, cereal grains, forest, fish, animals etc. For some
renewable resources, the continuation and volume of their flow depend crucially on humans. For

examples: soil erosion and nutrient depletion reduce the flow of food. Excessive fishing reduces
the stock of fish which in turn reduces the rate of natural increase of the fish population. Some
renewable resources can be stored and hence provides a valuable way to manage the allocation
the resource over time. Storage of depletable resources presents a different service from storage
of depletable resources. Storing depletable resources improves their economic life, on the other
hand storing renewable resources can serve as a means of smoothing out the cyclical imbalances
of supply and demand. The challenge for management of renewable resources is different from
the challenge for managing depletable resources. The challenge for depletable resources involves
Allocation dwindling stock among generations while meeting the ultimate transition to
renewable resources. In contrast, the challenge for managing renewable resources involves the
maintenance of an efficient sustainable flow.
1.2

Efficient Intertemporal Allocation:

Since we are dealing with the allocation of depletable and renewable resources over time, the
concept of efficiency can be termed as dynamic efficiency. Dynamic efficiency of resource
allocation assumes that societys objective is to maximize the present value of net benefits
derived from the use of the resource. For a depletable, non-recyclable resource, this requires
balancing of current and subsequent uses of the resources.
In economics, dynamic efficiency is a situation where it is impossible to make one generation
better off without making any other generation worse off. It is closely related to the notion of
"golden rule of saving". In general, an economy will fail to be dynamically efficient if the real
interest rate is below the growth rate of the economy (sum of the growth rates of population and
per capita income).
1.3

Natural Resource Management and Sustainable Development

A natural resource may exist as a separate entity such as fresh water, and air, as well as a living
organism such as a fish, or it may exist in an alternate form which must be processed to obtain
the resource such as metal ores, oil, and most forms of energy.
Renewable resource: Renewable resource is a natural resource which can replenish with the
passage of time, either through biological reproduction or other naturally recurring processes.
Renewable resources are a part of Earth's natural environment and the largest components of its
ecosphere. A positive life cycle assessment is a key indicator of a resource's sustainability.
Renewable resources may be the source of power for renewable energy. Sustainable harvesting
of renewable resources (i.e., maintaining a positive renewal rate) can reduce air pollution, soil
contamination, habitat destruction and land degradation.
Non-renewable resource: Non-renewable resource is also known as a finite resource and is a
resource that does not renew itself at a sufficient rate for sustainable economic extraction in

meaningful human time-frames. An example is carbon-based, organically-derived fuel. The

original organic material, with the aid of heat and pressure, becomes a fuel such as oil or gas.
Fossil fuels (such as coal, petroleum, and natural gas), and certain aquifers are all non-renewable
resources. David Ricardo in his early works analyzed the pricing of exhaustible resources, where
he argued that the price of a mineral resource should increase over time. He argued that the spot
price is always determined by the mine with the highest cost of extraction, and mine owners with
lower extraction costs benefit from a differential rent.
Carrying capacity: Use of natural resource services is compared with defined bio-physical
limits for the supply of such services.
Economic Approaches to Resource Management
In economics approaches to resource management, the common denominator is typically some
form of measurement that can be related to individual welfare. Economics provides a
comprehensive framework for analyzing most aspects of natural resource and environmental
issues. Optimal extraction and use of nonrenewable resources, in particular as analyzed by the
Hotellings rule. Economic indicators of sustainability derived from the weak sustainability view
that the total amount of capital must be maintained. The basic Hotelling Rule is based on a
number of simplifying assumptions. The total stock of resources is assumed to be known and of
equal quality, and all the market players are assumed to have full knowledge. The concept of
management of non-renewable resources is mainly concerned with how a resource stock should
be used optimally and not concerned with sustainability.
Major issues in use of natural resources
1. Productivity,
2. Equity and
3. Sustainability
Resource productivity: Resource productivity is the quantity of good or service (outcome) that
is obtained through the expenditure of unit resource. This can be expressed in monetary terms as
the monetary yield per unit resource.
Resource productivity and resource intensity are key concepts used in sustainability
measurement. The sustainability objective is to maximize resource productivity while
minimizing resource intensity
List of environmental issues
A.
B.
C.
D.
E.
F.

Climate change
Conservation
Energy Environmental degradation
Environmental health
Intensive farming
Land degradation

G.
H.
I.
J.
K.
L.
M.
N.

Soil
Land use
Overpopulation
Ozone depletion
Pollution
Water pollution
Air pollution
Reservoirs Resource depletion

Equity and issues in equity of natural resources: Equity derives from a concept of social
justice. It represents a belief that there are some things which people should have, that there are
basic needs that should be fulfilled, and that policy should be directed with impartiality, fairness
and justice towards these ends .Equity means that there should be a minimum level of income
and environmental quality below which nobody falls.
Intra-generational equity
Equity can also be applied across communities and nations within one generation. The reason
that intra-generational equity is a key principle of sustainable development is that inequities are a
cause of environmental degradation. Poverty deprives people of the choice about whether or not
to be environmentally sound in their activities.
Equity issues, key parameters and indicators:
1. The majority of people would be deprived in terms of low welfare level despite their hard
work (equity failure).
2. Unfair access to public infrastructure, facilities and services could occur (equity failure).
i.e. failure to guarantee intra- and inter-generational equity would cause deep inequality
and un sustainability
3. Natural resources may be so exploited that threaten their sustainability of use.
4. Negative externalities of economic activities could create serious threat to the
environment.
The nine equity issues are as below:
1.
2.
3.
4.
5.
6.
7.
8.
9.

Income and employment system

Access to facilities and services
Access to natural resources
Fairness in competition
Natural resource exploitation
Negative externalities
Non-production function
Compensation to worse
Sustainability reinvestment

Sustainability: The word sustainability is derived from the Latin sustinere (tenere, to hold; sus,
up). The most widely quoted definition of sustainability and sustainable development, that of the
Brundtland Commission of the United Nations on March 20, 1987: sustainable development is
development that meets the needs of the present without compromising the ability of future
generations to meet their own needs. The "three pillars" of sustainability are Environmental,
social and economic demands.
The word sustainability is applied not only to human sustainability on earth, but too many
situations and contexts over many scales of space and time, from small local ones to the global
balance of production and consumption. Sustainability is the capacity to endure.
In ecology, sustainability describes how biological systems remain diverse and productive over
time, a necessary precondition for human well-being. Long-lived and healthy wetlands and
forests are examples of sustainable biological systems. For example, sustainability farming is a
system that in which Natural Resource System (NRS) are managed so that the potential yield and
stock of Natural Resource System do not decline over time.
Principles and concepts
The philosophical and analytic framework of sustainability draws on and connects with many
different disciplines and fields. In recent years an area that has come to be called sustainability
science has emerged. Sustainability science is not yet an autonomous field or discipline of its
own, and has tended to be problem driven and oriented towards guiding decision-making.
Scale and context
Sustainability is studied and managed over many scales (levels or frames of reference) of time
and space and in many contexts of environmental, social and economic organization.
Consumption population, technology, resources
The total environmental impact of a community or of humankind as a whole depends both on
population and impact per person, which in turn depends in complex ways on what resources are
being used, whether or not those resources are renewable and the scale of the human activity
relative to the carrying capacity of the ecosystems involved.
To express human impact mathematically called as I PAT formula. This formulation attempts to
explain human consumption in terms of three components: population numbers, levels of
consumption and impact per unit of resource use, which is termed technology used.
The equation is expressed:
I = P A T
Where:
I = Environmental impact,

P = Population,
A = Affluence,
T = Technology
Sustainability measurement: Sustainability measurement is a term that denotes the
measurements used as the quantitative basis for the informed management of sustainability. The
metrics used for the measurement of sustainability (involving the sustainability of environmental,
social and economic) domains are evolving: they include indicators, benchmarks, audits,
sustainability standards and certification systems.
1.4

Theory of optimal use of exhaustible and renewable resources:

The theory of optimal use of exhaustible and renewable resources was first given by Harold
Hotelling in his 1931 paper The Economics of exhaustible Resources. He states that- the price
of an exhaustible resource must grow at a rate equal to the rate of interest both along an efficient
extraction path and in a competitive resource industry equilibrium.
Hotellings Rule can be stated as below:
Where

is price in period t,

is price in the initial period and

is the rate of

interest.

Hotelling's study was that in equilibrium the resource rent (the net price), defined as the
difference between the market price of the resource and marginal extraction costs, must increase
at a rate equal to the rate of interest. The underlying assumption is again that the producers in the
market possess exclusive rights to non-renewable natural resources. The only way of having a
return on preserving the resource stock, is that the net price of the resource increases over time.
In order for the asset market to be in equilibrium, the growth rate for the resource rent must equal
the opportunity cost, i.e. the interest rate or the return on investments.
1.5
Environment and development trade off and the concept of sustainable
development:

In the late 1980s and early 1990s some economists (Krueger and others) took up some studies
to explore the relationships between level of economic development and environmental quality
across countries. Plotting the concentration of certain key pollutants against per capita income
(PCI) of levels of countries some studies came up with a pattern of scatter shown in figure-2.
Pollution
Early stage of
Economic Development
Later Stage of Economic
Development

Per Capita Income

Fig: 2 The Environmental Kuznet Curve
This scatter indicated a relationship between per capita income (PCI) and pollution levels of the
shape of an inverted U. Owing to the remarkable similarity of this pattern to Kuznets findings
about two decades earlier between PCI and inequality across countries, this relationship came to
be known as the Environmental Kuznets Curve (EKC).
The hypothesis put forward by this curve states that environmental pressure tend to rise faster
than income growth in early stages, then sows down and reaches a turning point after which it
tend to decline with further growth. The last phase is referred as delinking of environmental
pressure from economic growth. The EKC hypothesis points towards a trade-off between
environment and development i.e. it seems to suggest that underdeveloped countries will have to
forgo environmental quality for the sake of attaining a higher level of development. It further
suggests that environmental quality will be taken care of as developing countries attain further
level of development.
At low level of development both the quantity and intensity of environmental degradation is
limited to the impacts of subsistence economic activity on the resource base and to limited
quantities of biodegradable wastes. As economic development accelerates with the
intensification of agriculture and other resource extraction and the take-off of industrialization,
the rates of resource depletion begins to exceed the rates of resource regeneration, and waste
generation increases in quantity and toxicity. At higher levels of development, structural and
services, coupled with increased environmental awareness, enforcement of environmental
regulations, better technology and higher environmental expenditures, result in leveling off and
gradual decline of environmental degradation.
An obvious policy suggestion which can be drawn from the trade-off is that developing countries
should focus primarily on growth and economic development goals without bordering much
about environmental protection in their early stages. Because growth itself will take care of
environmental quality at a later stage. However, such a strategy can be mistaken (as was the

growth oriented strategy of developing countries like India in the early planning era without
much effort for reduction of poverty, believing that poverty was supposed to be mitigated by
trickledown effect of high growth). Moreover, it is important to note that many components of
environmental quality such as biodiversity are non-reversible if degradation exceeds a threshold
levels.
In this context it seems that, despite the ambiguity associated with the concept, sustainable
development would be a better strategy. Moreover, a developing country today need not go
through the same course of development on which the rationale for the EKC hypothesis has been
formulated. For instance, countries like India have made the transition from a primary sector
dominated economy to a service sector dominated economy without going through the phase
dominated by the industrial sector. Such a pattern obviates the need for industrialization related
environmental degradation in the course of economic development. Even if a country needs and
chooses to industrialize it can leap-frog the course of technological advancement and adopt
technologies, which are substantially less polluting than the technologies used by countries
which industrialized in the past. The environment-development trade-off might have existed
historically. But it is not inevitable for a contemporary developing countries to sacrifice
environment quality for the sack of expediting the pace of development.
Sustainable Development
Sustainable development can be defined as Development that meets the needs of the present
without compromising the ability of the future generations to meet their own needs. This
concept can be Resonates with Economists conceptualization of income i.e., maximum
consumption one can have in a period while remaining as well off in the end as in the beginning
of the period. In that light sustainability has been interpreted as an obligation to conduct
ourselves so that we leave to the future the option or capacity to be as well off as we are. Hence
sustainability requires that the stock of capital manufactured, human and natural, is left
undiminished. This in turn needs restricting consumption to save resources for asset creation and
conservation and protection of the environment.
A week sustainable development views manufactured and natural capital to be substitutable in
which total stock of these assets matters whose monetary valuation is possible. Whereas a strong
sustainable development treats natural and manmade capital to be complementary so that they
can be used at the rate they regenerate and are measured in physical units.
1.6

Integrated environmental and economic accounting

System of environment and economic accounting (SEEA) is a result of sustainability which was
part of world commission on environment and development in report Our Common future
which defined sustainability as development that meets the needs of the present without
compromising the ability of future generations to meet their own needs. SEEA works on Asset
account, Pollution and material flow account, Environment protection & resource management
account and Macroeconomic indicators.
It extends the Asset Balance of Sustainability Natural account A to include Natural Capital, i.e.,
free gifts of nature such as mineral deposits, forests, fish stocks etc.

Structure of Asset Account:

Opening balance,
Change during the year (depletion/depreciation, gross capital formation, other volume change)
Due to economic activity extraction, harvest
Due to natural processes Birth, Death, Growth
Closing balance
Valuation Methods
Net Price Method
Present Discounted Value Method
Depreciation /Depletion calculation method
For non-renewable assets value of extraction at net price
For renewable assets value of harvest in excess of sustainable yield
A relatively new practice is to measure it as the change in asset value from year to year.
Material Flow Account
The material flow component of SNA is extended to incorporate generation of pollution in
production and consumption.
Append rows below the material flow matrix to record different pollutants generated in different
industries.
Similar exercise for final demand elements too is practiced.
Monetary account of pollution calculation:
(Maintenance/Avoidance Cost Approach: Damage Cost Approach Estimated by adding up Loss
of agricultural and loss of productivity of other assets.) Minus (-) Set appropriate pollution
standards- Accelerated corrosion of structures Minus (-) Estimate cost of bringing pollution level
to these standards from the existing levels i.e., Health damage.
Measure of sustainability:
Total Material Requirement (TMR)-Materials used are added up using weights to get TMR.
Dematerialization (reduced material requirement per unit of output) is taken as a measure of
sustainability.
Monetary Indicator:
1. Depletion Adjusted GDP (daGDP) = GDP Depletion of natural capital
2. Environmentally Adjusted NDP (aeGDP) = GDP- (Depletion of natural capital)
(Environment degradation based on maintenance cost approach)

3. Genuine Income (gY) = GDP- (Depletion of natural capital) (Environment degradation

based on damage cost approach)
4. Genuine Saving = (Gross Domestic Saving) (Consumption of fixed capital) (Depletion of natural capital) (Environment degradation based on damage cost
approach)
Positive genuine saving means that the weak sustainability norm is fulfilled.
Sustainable National Income: The National Income the economy would have had if it had met
all the environmental standards using existing technology.
1.7

Environmentally Corrected GDP or Green GDP

All uses of biodiversity are not incorporated in economic accounts and this leads humans to
under-value biodiversity. Ecosystem services and resources such as mineral deposits, soil
nutrients, and fossil fuels are capital assets but traditional national accounts do not include
measures of the depletion of these resources. This means a country could cut its forests and
deplete its fisheries, and this would show only as a positive gain in GDP (gross domestic
product) without registering the corresponding decline in assets (wealth). This is where Green
GDP comes into play. The green GDP is the measurement of GDP growth with the
environmental Consequences of that growth factored in.
Green DGP means
1. Monetization of the loss of biodiversity
2. Accounting for costs caused by climate change
3. Subtracting resource depletion, environmental degradation from traditional GDP figures.
4. Helping to manage both economic as well as resources.
But it does not mean monetary value of the forest and growth of green investment.
Environmentally Adjusted NDP (aeGDP) = GDP- (Depletion of natural capital)
(Environment degradation based on maintenance cost approach)
The relationship between biodiversity and ecosystem function is clear but a major question in
ecology is how much biodiversity is required to maintain ecosystem function. Green Gross
Domestic Product is the index of the Economic growth of a particular country which enshrines
the environment consequences of the economic growth. Kindly note that Green GDP means that
it accounts the monetized loss of biodiversity, costs caused by climate change. Green GDP is
conventional gross domestic product figures adjusted for the environmental costs of economic
activities. Its a measure of how a country is prepared for Sustainable economic development.