Renewable and Non-renewable resources

RENEWABLE AND NON-RENEWABLE RESOURCES

(Summary of Module Eight)

Introduction to Resource Economics

Renewable resources are those for which there is a natural replenishment augmenting the flow at a non-negligible rate. A depletable resource is that for which the feedback loop is negligible so there is a risk of running out. The Depletion rate depends on the durability and reusability of a resource. The challenge that resource economists try to deal with here is that of sharing a depletable unrecyclable resource sustainably across generations, and to gradually make the transition to suitable renewable substitutes. The challenge is somewhat different in the case of renewable resources. For renewable, the challenge involves maintaining efficient sustainable flow so as not to overshoot the rate of natural replenishment.

There are two models that explain intertemporal allocation of finite resources: The Two period Model, which explains how resources are allocated between two periods according to the resource’s demand curve, and the N-Period Model, which explains the allocation over a large number of years. The former explains why more than half of the resources would be used in the first period. A variable called Marginal User Cost is used to measure the opportunity cost of production involving the particular resource today precluding the production of the same in the future. The N-period model is an extension of this same concept. It explains how the Marginal User Cost, together with Marginal Cost of Extraction, rises steadily with increasing scarcity of the resource, until the combined value of the two (Total Marginal Cost) reaches the highest price anyone is willing to pay for a unit. In cases where a renewable substitute is available, the Total Marginal Cost only rises up to the point where it equals the Marginal Cost of the substitute, at which point the society switches to the substitute. But this switch point could be prolonged by technological progress and exploration activities which bring down the extraction costs of the depletable resource.

Marginal User Cost is a useful concept as it helps account for the asset value of the resource, the value that the owner stands to gain by leaving the resource under the ground in conditions of rising prices. Thus a producer who maximizes the value of the resource would be interested in conserving it for the future. Hence, the conclusion that, ‘as long as private and social discount rates coincide, property rights are well defined and reliable information about future prices available, a producer who selfishly pursues maximum profits simultaneously provides maximum present value to society’(Tietenberg, 128)

Government interventions to conserve depletable resources have often taken the form of price controls. One only needs to look at the case of Natural Gas in the U.S to see how this could fail miserably. As a result of the price controls imposed, share of gases in the interstate markets fell and inefficient substitutes promoted. This is because producers were overproducing due to falling of Marginal User Cost (as higher future prices cannot be expected). Future consumers are also made worse-off as the supply only lasts till the Marginal Extraction Cost meets the level of price control. Thus the transition to renewable resource is hastened. Unfortunately, the loss to future consumers is much more than the marginal benefits to current consumers which makes it an all-round inefficient scenario.

To understand how organized private interests or cartelization affects the utilization of a resource, let us take the oil example. OPEC currently produces two-third’s of the world oil. Upon careful observation, it is possible to isolate factors that affect cartelization of a resource as:

  1. Price Elasticity of Demand
  2. Income Elasticity of Demand
  3. The supply responsiveness of other producers
  4. The compatibility of interests among members coming together to form the cartel

The last point is particularly important and is quite well illustrated in the OPEC example. At any point, an OPEC member can cheat the cartel and sell oil at a lower price stealing the market away from the others. But even other than that, OPEC members have reserves of different sizes. The incentives of Saudi Arabia (which holds 33% of OPEC’s reserves) would be to preserve the value of the reserves for a long time by not pricing it too high leading to the undercutting of demand for oil. In comparison, a country with smaller reserve would not be so bothered about preserving value for the future and would possibly stand for extracting as much as possible now. But the size of the reserves gives Saudi Arabia a greater say in price setting within the cartel.

Economics of Renewable Resources

The line dividing exhaustible resources and renewable resources is not clearly drawn. Just as exhaustible resources, in a sense, can be renewed through exploration and technology, renewable resources can be exhausted. They are naturally regenerated on a time frame that is relevant to human exploitation.

But unless the population has already been reduced to the point of the critical threshold, natural growth will replenish the loss of biomass due to the harvest within a relatively short period.

Renewable natural resources include those resources useful to human economies that exhibit growth, maintenance, and recovery from exploitation over an economic planning horizon. The economics of such resources has traditionally considered stocks of fish, forests, or freshwater, much like a banker would tally interest on cash deposits. From an economic point of view, the management of biomass, soil fertility or aquifer depth has been forced into a framework of discounted, marginal, zero profit valuation. Economic value has been discounted to account for a positive time preference. Only marginal value (that of the next unit) is considered relevant to market-based decisions and all economic profits (including a normal return to factor inputs) should be driven to zero to maximize the sum of consumer and producer surplus at a social optimum. This framework can aptly be described as dynamic optimization and expanded to include risk and uncertainty, a social (vs. private) rate of time preference, non-market values, and systems without bias toward equilibrium.

The principal economic question in the management of renewable natural resources has been: How much of a resource should be harvested during the present vs. future time periods? Time is typically considered over the horizon of a single representative manager or economic operation. For instance, in ocean fisheries the economic question has been how much to harvest this season and how much to leave in the sea as a source of future growth next season. To strike this balance, economists have used methods of dynamic optimization (i.e. the best allocation over time). A renewable resource problem is typically framed as a maximization of some single measure of net economic value over some future time horizon, subject to the natural dynamics of the harvested resource, an initial stock size, a target for the end of the planning horizon (or a limit in the case of an infinite-time horizon), a measure of time preference, and other relevant market, price, and technology constraints. Advances in the treatment of risk and uncertainty, measurement of social versus private time preference, capture of non-market amenities, and analysis of non-equilibrium behavior have further extended this paradigm of efficient allocation.

The model described here assumes the growth of natural stock as logistic. The natural stock can grow to the maximum limit(Xmin) subject to the carrying capacity of the eco system. But when the stock gets depleted below a critical minimum (Xmin),- the minimum viable population  the renewable resource loses its regeneration ability and becomes extinct. When you consider the growth pattern, the growth follows a bell shaped pattern with the growth maximized at Xm , and at this point, the maximum sustainable yield occurs. If we harvest the renewable resource in such a way that we take MSY from the stock, it will regenerate itself and we can get MSY again in the next period, and so on.

Market, Free (Open) Access and Common Property Solutions

What is the difference between efficient allocation and competitive market allocation of renewable resources? A competitive sole owner is supposed to have well defined property rights. This will be at MR=MC, i.e.  the static efficient sustainable yield. What could be the consequences when access to the resources is completely unrestricted? Free access resources generate two kinds of generalities. 1. A contemporaneous externality which is borne be current generation and it involves congestion due to over- commitment of resources to fishing. As a consequence, current fishermen earn a substantially lower rate of return on their effort

2. An inter-generational externality which is borne by the future generations.

When access to the renewable resource is fee, an incentive to expend effort by each fisherman beyond E­c reduces profit to the whole group as such. Every one imposes a burden on everyone else. At the efficient level, each individual receive a profit equal to its share of the scarcity rent. However, this rent serves a stimulus for new fishermen to enter, driving up costs and eliminating rent. Hence open access results in over – exploitation of resources.

A resource owner with exclusive property rights would balance the use value against the asset value of the resource (that is, would consider future flow of returns also). When the access of the resource is unrestricted, exclusivity is lost. It is then rational for the individual exploiter to ignore the asset value, as he can never appropriate it. The process will dissipate all the scarcity rent.

The condition under which the renewable resource will get extinct is the following

  1. The effort is costless-effort is at Emax and goes to zero
  2. Harvest levels are above the natural rate of regeneration
  3. The risk of resource extinction is high if there is a critical minimum size of population (Xmin).

On the other hand, a common property resource is one that is owned by a defined group of people. But there can be free access for members of the group. But it is very likely that the group will have rules and norms to use, restricting the use that any one is allowed to make of the resource.

Economics of Non-renewable resources

Till now we have seen the optimal exploitation rate for a renewable resource. However, most of the resources used today are non-renewable, exhaustible. While we were concerned with the optimal rate of use of the resource in case of renewable resources, our concern in case of non-renewable resource is to find the optimal rate of depletion of the resource. It is important to understand the effects of different rates of exploitation. Since the resource will be exhausted at some point of time in the future, the important questions to be asked are

  • How long the resource is going to last
  • What should be the optimal price of the resource
  • What is the switch point
  • Does the backstop technology come in use in an efficient way

The optimal rate of depletion is given by Hotelling’s rule, named after Harold Hotelling. This rule states that the price of any resource in any time period ‘t’ is equal to the price in some initial period compounded at a given discount rate. Therefore the owner would be indifferent between extracting the resource now and extracting it afterwards in case the discounted value of the resource remains unchanged. This implies that the resources in the grounds are treated as capital assets. Till now, we have assumed that the extraction cost is zero. However, if we do introduce some positive extraction costs in our model, the optimal price of the resource in all time periods will change. The optimal price of the resource will now be given by the sum of the marginal extraction cost of the resource and the marginal user cost (also referred to as royalty or the resource rent which is the appreciation in the value of the resource that has not been extracted).

Our problem now, is to find a way to determine the initial optimal price as well as the time period in which the resource will be exhausted. For determining these two, we introduce the concept of the “price of the backstop technology”. Since the resource under consideration is an exhaustible one, the price of the resource is going to be higher as lesser and lesser quantities of it are available. In other words, the exhaustible resource will be supplied at a very high price. At some point of time, even though the resource may not have been fully exploited, the price of the resource may be so high, that some alternate technology or resource which was not economically viable earlier becomes viable. This particular point is referred to as the switch point.

Now, we have the optimal price path given by the Hotelling’s rule. We also have the price of the backstop technology. Therefore, we can work in a reverse direction and figure out the initial optimal price. The optimal price will “deplete the resource at a rate which smoothly permits the transition from the existing resource to a backstop resource”.

Effects of change in parameters

In this section we look at the effect on the rate of resource depletion and the original price of changes in the parameters we have used so far in our analysis. These parameters are the discount rate, the price of the backstop technology, the stock of the resource, the cost of extraction and the demand for the resource.

Parameter which undergoes change Change in the parameter Initial optimal price Time period for which the resource is used Mechanism
Discount

rate

Increases Decreases Decreases Higher discount rate leads to more rapid exhaustion of the resource

Resources become more valuable in the present than in the future

Price of the backstop technology Decreases Decreases Decreases Since the backstop technology becomes cheaper, the switch point is reached earlier
Stock of the resource Increases Decreases Increases Increase in the stock through discoveries of new reserves or new extraction technologies pushes the price path outward and downward, thus lowering the initial optimal price
Cost of extraction of the resource Decreases Decreases Decreases Recall that( optimal price = extraction cost + marginal user cost)

Therefore, a decrease in the extraction cost leads to a decline in the initial price

Demand for the resource Increases Increases Decreases If demand increases, then the demand curve will shift outwards and consequently the price path of the resource will shift inwards (to the left).

Hence, price will increase and the resource will be depleted sooner

Monopoly and the rate of extraction

A common perception is that a monopolist in control of an exhaustible resource would deplete the resource at a rate higher than the optimal rate and hence the resource will be exhausted in a shorter time period. However, a very simple economic rationale for monopoly behavior dictates that the monopolist would restrict output and charge prices higher than those that would have prevailed under perfect competition. This implies that the initial optimal price will be higher in the case of monopolist. Also, since the price charged is higher, there will be a lower demand for the resource. Thus, the effect is to increase the life of the resource stock. Therefore, a monopolistic control over exhaustible resources tends to conserve the resource. The exact difference in the rate of exploitation (from a perfectly competitive scenario) however, can depend on the elasticity of the demand curve for the resource

Source :

Titenberg. T (1998), Environmental Economics and Policy , 2nd Edition, USA, Addison Wesley

Pearece D, and RK Turner, Economics of Natural Resources and the Environment, New York, Harvester and Wheatcheef

Hanley, Nick, N.J. Shrogen, and B .White , Environmental Economics in Theory and Practice


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