Ambo University

College of Business and Economics

MSc. in Development Economics
Course: Natural Resource and Environmental
Economics: Course code: Econ 6071
Lecture Note
Instructor: Derese G. (Assistant professor)
2016 E.C

1 Derese G.(Assistant Professor)

 Chapter One:
Introduction to Natural Resource and
Environmental Economics
1.2. Definition and Concept

Natural ressources vs environnemental ressources?

Economics?
Natural resources economics?
Environmental economics?
Natural resources and Environmental economics?

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 Cont’d…
Natural ressources vs environnemental ressources
Natural resources: are taken to be those components of land units that are direct
economic use includes stocks of fish, stands of trees, fresh water, oil, and other naturally
occurring resources.
 resources provided by nature that can be divided into increasingly smaller units and allocated at the
margin.
Environmental resources: are taken to be those components of the land that have an
intrinsic value of their own, or are of value for the longer-term sustainability of the use of
the land by human population.

They includes biodiversity; scenic, educational or research value of landscapes; protective

value of vegetation in relation to soil and water resources; the functions of the vegetation
as a regulator of climate and of the composition of the atmosphere; water and soil
conditions as regulators of nutrient cycles.

resources provided by nature that are indivisible.

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 Cont’d…
Natural resources serve as inputs to the economic system.

Environmental resources are affected by the system (e.g.

pollution).

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 Cont’d..
Economics: Science of allocating scare resources among competing
uses
Natural resources economics
 Study how society allocate natural resources such as stocks of fish,
stands of trees, fresh water, oil, minerals and other naturally
occurring resources.
 Optimal allocation of natural resources over time under different
market settings.
 concerned with the production and use of both renewable and
non-renewable character natural resources
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 Cont’d…
Environmental economics
is concerned with the analysis of the impact of economic activities on the
environment, the significance of the environment to the economy and
appropriate way of regulating economic activity so that balance is achieved
among environmental, economic and other social objectives. It is concerned
with welfare economics, the economics of pollution, valuation techniques, and
environmental policies
focuses on all the different aspects of the connection between environmental
quality and the economic behavior of individuals and groups of people.
Therefore, EE is the application of the principles of economics to the study of
how environmental resources are developed and managed.

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 Cont’d…

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 Cont’d…
Natural Resource and Environmental Economics
It is the application of economic theories, principles and methodologies
to the proper utilization, allocation and management of natural
resources and our environment.
It undertakes theoretical or empirical studies of the economic effects
of national or local environmental policies around the world on the
environment
It is also an application of various economic theories and design of
instruments for environmental governance to solve problems like air
and water pollution, loss of bio–diversity and perturbances in to the
ecosystems health etc. Generally, it is a policy science.

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 1.2. Inter-linkages Between the Economy &
the Environment

The economy:

• all economic agents

• their institutions

• the interlinkages between the institutions and the agents

The environment:

• Atmosphere: air

• Hydrosphere: water resource

• Geosphere: land, mineral, etc.

• Biosphere: plants and animals

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 The Economic System and the Environment

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 Cont’d…
The economy is simplified into two sectors (production and
consumption).
 Exchange of goods, services and factors of production take
place in these sectors.
The environment is shown in two different ways: one of them
is the three interlinked circles, E1, E2 and E3 and the all-
encompassing boundary labelled E4.
 Clearly, economic activity operates within E4, and thus is
shown as being encapsulated by it.
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 Figure 1 Economy-environment interactions

E4- Global life service support

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 Cont’d…
E1: Here the role of the environment is supplying resources;
 production extracts energy and materials from the environment, transforms them
into outputs (useful goods traded with consumers and harmful-emissions such as
SO2).
 some recycling in production and consumption (loops R1 and R2)

E2: Here the environment serves as a sink/receptor

 Limited assimilative capacity for waste
 But we mostly have increasing damage and the rate of increase may exhibit
abrupt changes due to ‘threshold’ effects
The effects of waste on the environment depend on the type/nature of the pollutant

 ‘Cumulative’/’’conservative’/non-biodegradable pollutant
 Assimilative/degradable pollutants:
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 Cont’d…
E3: The environment acts as a supplier of amenity, educational and spiritual
values to society.

 Non natives may derive pleasure from the existence of wilderness areas or
rainforests.

 Natives may attach spiritual and cultural values to them, and the flora and
fauna therein.

 Economists ‘count’ these values

 Economic value is dependent on social well-being, measured in a particular

way the sum of individuals levels of well-being.

 Individual well-being is measured by utility, thus social welfare is the sum of

individual utilities represented in the following generalized way:
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 Cont’d…
U A  U ( X 1 , X 2 ,... X n ; Q1 , Q2 ,..., Qm )
Where
 UA is utility,
 (X1... Xn) are produced goods and services, and
 (Q1... Qm) are environmental assets.
The environment supplies utility to individual A
 directly via the vector of assets, and
 indirectly via its roles in the production of the vector of goods and services (X1... Xn).
E.g. X1 is consumption of services of a car, but the use of car decreases air quality, Q1. An
increase in the consumption of ‘car services’ increases utility.
 U A
 0
 X 1

but this increase in car use decreases air quality

Q 1
 0
X 1

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 Cont’d…
 Fall in air quality reduces utility in an amount
U A Q1
Q1 X 1
 Net effect-ambiguous: depends on the relative strength of these positive and
negative changes.
E4: represents the global life-support services provided by the environment
These include
 maintenance of an atmospheric composition suitable for life

 maintenance of temperature and climate:

 recycling of water and nutrients.

Examples are the hydrological, carbon and oxygen cycles.

 Clearly, economic activity operates within this environment.
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 1.3. The three themes of natural and
environmental resource economics
The three themes that run through this course are:
 efficiency,
 optimality and
 Sustainability

Efficiency: signifies a level of performance that describes using the least amount of input to
achieve the highest amount of output. Efficient refers to the ability to accomplish a task or goal
with the least amount of waste, effort, or time.

 One way of thinking about efficiency is in terms of missed opportunities.

 If resource use is wasteful in some way then opportunities are being wasted;

eliminating that waste (or inefficiency) can bring net benefits to some group of
people.

 Eliminating waste/inefficiency => increase net benefits

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 Cont’d…
Optimality
Optimality is related to efficiency, but is distinct from it.

To understand the idea of optimality we need to have in mind:

1. a group of people taken to be the relevant ‘society’;

2. some overall objective that this society has, and in terms of which we can measure

 the extent to which some resource-use decision is desirable from that society’s point of

view.

 Then a resource-use choice is socially optimal if it maximizes that objective given to any

relevant constraints. Utilization of resources which maximize the benefit of the society
(among generation)

 the reason they are related is that a resource allocation cannot be optimal unless it is

efficient.
Derese G.(Assistant Professor)
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 That is, efficiency is a necessary condition for optimality.
 Cont’d…
• However, efficiency is not a sufficient condition for

optimality; in other words, even if a resource allocation is

efficient, it may not be socially optimal.

 This arises because there will almost always be a

multiplicity of different efficient resource allocations, but

only one of those will be ‘best’ from a social point of
view.

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 Cont’d…
Sustainability
 sustainability involves taking care of posterity (all of future
generations).
 If an allocation of resources is socially optimal, then surely is it
must also be sustainable?
 The pursuit of optimality as usually considered in economics will
not necessarily take adequate care of posterity.
 If taking care of posterity is seen as a moral obligation, then the
pursuit of optimality as economists usually specify it will need to be
20 constrained
Derese G.(Assistantby a sustainability requirement.
Professor)
 1.4. Fundamental Issues: features of the economic approach
to resource and environmental issues

Four features of the economic approach to resource and

environmental issues:

1. Property rights, efficiency and government intervention

2. The role and the limits of valuation, in achieving

efficiency

3. The time dimension of economic decisions

4. substitutability and irreversibility

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 Cont’d…
1. Property rights, efficiency and government intervention

 a central question in R and EE is allocative efficiency.

 The role of markets and prices is central to the analysis of this question.

 A central idea in modern economics is that, given the necessary

conditions, markets will bring about efficiency in allocation.

 Well-defined and enforceable private property rights are one of the

necessary conditions.

 Because property rights do not exist, or are not clearly defined, for

many environmental resources, markets fail to allocate those resources

efficiently.
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 Cont’d…
Price signals fail to reflect true social costs and benefits, and this
calls for government policy interventions to seek efficient gains.
 Deciding where intervention is needed and what form it should
take are central issues in all R and EE
 Some environmental problems cross the boundaries of nation
states and are properly treated as global problems.
 In such cases there is no global government with the authority to
act on the problem in the same way as the government of a
nation state might be expected to deal with a problem within its
borders.
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 Cont’d…
2. The Role and the Limits of Valuation, in Achieving Efficiency
 As just observed, many environmental resources – or the services
yielded by those resources – do not have well-defined property
rights.
 Clean air is one example of such a resource.
 Such resources are used, but without being traded through markets,
and so will not have market prices.
 A special case of this general situation is external effects, or
externalities.
 an externality exists where a consumption or production activity has
unintended effects on others for which no compensation is paid.
Here, the external effect is an untraded and un priced.
e.g. Sulphur emissions from a coal-burning power station.
 However, the absence of a price for a resource or an external effect
24 does notG.(Assistant
Derese mean Professor)
that it has no value/effect.
 Cont’d…
 Clearly, if well-being is affected, there is a value that is either
positive or negative depending on whether well-being is ed
or ed.
 In order to make allocatively efficient decisions, these values
need to be estimated in some ways.
 Returning to the power station example, government might wish
to impose a tax on sulphur emissions so that the polluters pay for
their environmental damage and, hence, reduce the amount of it to
the level that goes with allocative efficiency.
 There are various ways of doing this – collectively called valuation
techniques.
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 Cont’d…
3. The Time Dimension of Economic Decisions
 Natural resource can be classified: ‘stock’ and ‘flow’ resources.

Stock resources: plant and animal populations and mineral deposits,

have the characteristic that today’s use has implications for tomorrow’s
availability, this is not the case with flow resources.
Flow resource: solar radiation, and the power of the wind, of tides and
of flowing water. Using more solar radiation today does not itself have
any implications for the availability of solar radiation tomorrow.
 Within the stock resources category there is an important distinction
between
‘renewable’ and ‘non-renewable’ resources.
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 Cont’d…
Renewable resources are biotic, plant and animal populations, and have the
capacity to grow in size over time, through biological reproduction.
Non-renewable resources are abiotic, stocks of minerals & energy resources, &
do not have that capacity to grow over time. They are sometimes referred to as
‘exhaustible’, or ‘depletable’
 Renewable resources are exhaustible if harvested for too long at a rate
exceeding their regeneration capacities.
 In considering the efficiency and optimality of their use, we must take account not
only of use at a point in time but also of the pattern of use over time.
 Efficiency and optimality have, that is, an inter-temporal (dynamic) as well as
an intra-temporal (static) dimension
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 Cont’d…
4. Substitutability and Irreversibility

 If the depletion of a resource stock is irreversible, and there

is no close substitute for the services that it provides, then

clearly the rate at which the resource is depleted has major
implications for sustainability.

 To the extent that depletion is reversible and close substitutes

exist, there is less concern about the rate at which the

resource is used.

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 Cont’d…
 The assets available to society, now and in the future, comprise:

1.Natural capital: refers to ecological services provided by forests, fisheries, etc and minerals such
as oil, coal, etc. water, land, crude oil and gas, forest, fisheries, biomass, the earth
atmosphere

2.Physical capital: plants, equipment, machinery, buildings, infrastructure, etc

3.Human capital: ” is our knowledge or skills that are used for productive means. Stocks of
learned skill(“embodied skills“)

4.Intellectual capital: state of technology and culture (“disembodied skills“)

 Sustainable livelihoods require these assets.

 Some of these can be accumulated over time. Others cannot be –they are either finite,

or there are limits to their accumulation.

 So, as we move through time, to what extent can those resources which can be

accumulated substitute
Derese G.(Assistant Professor)for those which cannot (or which are depleted)?
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 Cont’d…
 There are two main dimensions to substitutability issues.

1st , there is the question of the extent to which one natural resource
can be replaced by another.
 Can, for example, solar power substitute for the fossil fuels on a
large scale? This is an important question given that
 the burning of fossil fuels not only involves the depletion of non-
renewable resources, but also is a source of major environmental
pollution problems (greenhouse effect).
2nd there is the question of the degree to which an environmental
resource can be replaced by other inputs, especially the human-
made capital resulting from saving and investment.
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 1.5. The two views of the prospect in
the environment

Pessimist View
Optimist View

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 2.5. The two views of the prospect in
the environment
The Basic Pessimist Model
 The model is characterized by exponential growth coupled with fixed limits.

Resources are held in fixed supply by the model (land, depletable resources etc)

Conclusions of pessimist model

I. Within a time span of less than 100 years with no major change in the physical, economic or social
relationships that have traditionally governed the world development, society will run out of non-
renewable resources on which the industrial base depends. When the resources have been depleted, a
precipitous collapse of the economic system will result, manifested in massive unemployment, decreased
food production, and a decline in population as the death rate soars. There is no smooth transition; no
gradual slowing down of activity, rather, the economic system consumes successively larger amounts of the
depletable resources until they are gone. The characteristic behavior of the system is overshoot and
collapse.
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 Cont’d…
II. Piecemeal approaches to solving the individual problems will not be
successful. The removal of one limit merely causes the system to bump
subsequently into another one, usually with more direct consequences. If the
depletable resources and pollution problems were somehow, jointly solved,
population would grow unabated, and the availability of food becomes the
binding constraint.

III. The third conclusion is: overshoot and collapse can be avoided only by an
immediate limit on population and pollution, as well as a slow/smooth
economic growth.
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 Cont’d…
The Basic Optimist Model
 The optimist scenario acknowledges the fact of Rising rates of depletion of non-
renewable resources and increasing flows of environmental wastes. But the
advocates of this view believe that markets can serve as regulators of resource
use to overcome both scarce of resources and environmental problems associated
with economic activity.
 Consider the issue of resource depletion, as resource become more and more scarce
their price would increase that is scarcity triggers higher prices. Higher relative
prices for scarce resources: Stimulate suppliers to decrease the use of resources,
encourage the adoption of production methods which use relatively fewer scarce
resources in proportion to other inputs, Promote materials recycling, Stimulate the
development of substitutes. This should allow growth to proceed unconstrained by
absolute resource limit
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 Cont’d…
 Consider the issue of rising levels of pollution, as waste flows
increase the cost of waste disposal and management rises. This
will encourage producers to minimize their cost by employing
more efficient technology that produces less waste .
 According to the optimists view consequences of the growth
process induce rising resource prices and result in increasing
costs of waste disposal and economies would adjust to higher
relative prices by adopting more efficient technology and
changing their technological coefficients to economize on
35 scarce resources.
Derese G.(Assistant Professor)
 Cont’d…
Conclusion of the optimist model
 “………… 200 years ago almost everywhere human beings were comparatively few, poor and at

the mercy of the forces of nature, and 200 years from now, we expect, almost everywhere they will
be numerous, rich and in control of the forces of nature” advocated by Kahn and his associates.

 The future path of population growth is expected to approximate an S-shaped logistic

curve. The retrospective glance would reveal a period of exponential population

growth, while the glance into the future would reveal continued growth, but with
steadily declining growth rates, until, at the end of the next few year period, growth
would automatically come to a halt. To Kahn and his associates, interference with this
natural evolution of society would not only be unwarranted, it would be unethical.

 Their model is more qualitative than the limits to growth model and therefore its

36 structure is less specific.

Derese G.(Assistant It is not a computer program that simulates the future.
Professor)
 Cont’d…
 In contrast to pessimists’ model, food production will rise so rapidly as to create an
eventual abundance of food. This vision in turn, depends on some specific sources of
optimism.
 Physical resources will not effectively limit production during the next few years, and

 Substantial increases can be expected in conventional foods produced by conventional or unconventional means
and unconventional foods produced by unconventional means.

 All of these sources of optimism are related to technological progress such as:
irrigation systems, better farming techniques, development of new hybrid seeds,
hydroponics:a process of raising food using no soil.
 When all of these lists are combined, the prevailing message is that currently
recognized technologies can overcome the limitations envisioned by the limits to
growth view. The cliché, “Necessity is the mother of invention” captures the
flavor of the belief of Kahn and his associates that these technologies will be developed
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as they are needed.
 End of Chapter one

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