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About this book

This book, based on lectures on natural and environmental resource economics, offers a nontechnical exposition of the modern theory of sustainability in the presence of resource scarcity. It applies an alternative take on environmental economics, focusing on the economics of the natural environment, including development, computation, and potential empirical importance of the concept of option value, as opposed to the standard treatment of the economics of pollution control. The approach throughout is primarily conceptual and theoretical, though empirical estimation and results are sometimes noted. Mathematics, ranging from elementary calculus to more formal dynamic optimization, is used, especially in the early chapters on the optimal management of exhaustible and renewable resources, but results are always given an economic interpretation. Diagrams and numerical examples are also used extensively.

The first chapter introduces the classical economists as the first resource economists, in their discussion of the implications of a limited natural resource base (agricultural land) for the evolution of the wider economy. A later chapter returns to the same concerns, along with others stimulated by the energy and environmental “crises” of the 1970s and beyond. One section considers alternative measures of resource scarcity and empirical findings on their behavior over time. Another introduces the modern concept of sustainability with an intuitive development of the analytics. A chapter on the dynamics of environmental management motivates the concept of option value, shows how to compute it, then demonstrates its importance in an illustrative empirical example. The closing chapter, on climate change, first projects future changes and potential catastrophic impacts, then discusses the policy relevance of both option value and discounting for the very long run.

This book is intended for resource and environmental economists and can be read by interested graduate and advanced undergraduate students in the field as well.

Table of Contents

Frontmatter

Chapter 1. The Classical Roots of Resource Economics

Abstract
This chapter begins by asking why we study resource and environmental economics, and answers: To know what economic theory and related empirical findings can tell us about a variety of interesting and important issues in this area, from rates of use of extractive resources, to more recent concerns about sustainability and climate change. All can be considered to derive from the Classical Economists, Malthus and Ricardo, who focused on the most important resource of the time, agricultural land. For Malthus, population (labor) was growing exponentially while land was fixed in supply, or growing very slowly if at all, leading ultimately by the law of diminishing returns to a large population living at the subsistence level. Ricardo shifted the focus to points along the way, where land of a given quality was fixed, but cultivation could shift to the next best land when diminishing returns set in, giving rise to the phenomenon of rent, or the return to each unit of the higher quality land. An example of the computation of rent is given, and the chapter closes with a short discussion of the insights and deficiencies of the classical analysis.
Anthony C. Fisher

Chapter 2. Optimal Depletion of Exhaustible Resources

Abstract
Exhaustible resources are non-producible and in that respect different from renewable resources, considered in the next chapter. Optimal depletion over many periods is about the tradeoff between the net benefits of extraction today and the net benefits of extraction in the future. The key insight here is that extracting a unit of the resource today carries an opportunity cost beyond the cost of the inputs used in extracting, the value that might have been obtained by extracting at some future date. The question is: What is the time pattern of extraction that maximizes the net present value of the resource in the ground? This is a constrained optimization problem, solved using elementary calculus techniques to obtain the result that the opportunity cost, the difference between price and marginal extraction cost, also known as the royalty, must grow at a rate equal to the rate of interest (here understood as the theoretically correct rate rather than an empirical rate which might be influenced by political manipulations or economic imperfections). Equivalently, the present discounted value of the royalty must be the same across all periods. If this were not so, some gain could be had by shifting a unit of extraction from a lower value period to a higher, so the initial configuration would have been neither efficient nor an equilibrium. Further results are developed in a variety of models ranging from a simple two-period model to extraction over many periods, including how to find the optimal exhaustion date for a mine, the effect of shocks and market imperfections, and finally to the case of continuous extraction. Simple algebraic and geometric analyses and many worked examples are used, along with graphical presentations. A major focus throughout is the relation between the socially efficient rate of extraction and the market-determined rate. For the continuous case, the mathematics of dynamic optimization, in particular optimal control, is introduced and applied to the resource problem, yielding additional insight into the solution. This will prove useful also in the next chapter on renewable resources such as forests, characterized by continuous growth.
Anthony C. Fisher

Chapter 3. Renewable Resources

Abstract
Turning to renewable resources, the new feature is some process for regeneration, accomplished by introducing a biological growth function, the widely applicable logistic law, into the optimal control model for exhaustible resources. Although a quite different result might be expected, and this is in fact the case, it turns out that the optimal management regime can be characterized in a way that also centrally involves the rate of interest. Depending on assumptions about the behavior of the growth function and the interest rate, a variety of outcomes are derived. In particular, under certain conditions the bio-economic optimum can be shown to be equivalent to what might be called a purely biological optimum, the maximum sustainable yield. This analysis has been for a generic renewable resource. The chapter also develops a model for the optimal harvesting of a particular resource, timber, or more generally forest management. This involves no mathematics beyond the elementary calculus used in the modeling of optimal extraction of an exhaustible resource, though now in a setting of continuous time and, following the conventional treatment, the decision variable is the optimal harvest date or rotation period rather than the amount of timber to be harvested at each point in time. Four cases are considered: the optimal harvest date for a one-shot harvest (which might be appropriate for a very slow-growing species); the optimal rotation period where repeated harvests are indicated, the conventional approach; a purely biological model, in which the objective is to maximize not value but the sustainable physical yield, which is contrasted with the bioeconomic model as in the case of a generic renewable resource; and the same analyses (though it is sufficient to look at how results are affected in the first case, the one-shot harvest) taking into account that a standing forest can also provide value. This leads quite naturally to the next chapter, on environmental dynamics.
Anthony C. Fisher

Chapter 4. Environmental Resources: Dynamics, Irreversibility and Option Value

Abstract
This chapter begins with a short discussion of the evolution of environmental economics, with links to theories of externalities and public goods and a focus on pollution. The focus then shifts to a less-studied aspect: the economics of natural environments. The idea that the environment from which commercially valuable resources are taken may have value in its natural state motivates a discussion of how this affects a benefit/cost analysis of the resource development project. This in turn leads to the concept of irreversibility, joined to uncertainty concerning evaluation of the environmental services that would be lost in perpetuity, or at least in the very long run if the resource development project goes forward. Examples are given to motivate the realism and potential importance of this approach. A theoretical discussion of investment under uncertainty and irreversibility is presented, verbally and graphically, which leads to the concept of option value (real, not financial), in turn given an analytical treatment, including an example of how to compute. The potential empirical importance of option value is illustrated in an application to a forested area in Thailand, in which each of four zones can be either preserved, developed, or given an intermediate level of development, in each of three periods. The states are distinguished by appropriate uses but subject to an irreversibility constraint, formulated as a decision tree of feasible sequences. For example, commercial agriculture can follow preservation but not vice versa. Results of an exercise using illustrative values show that option value, though small in relation to total use values, can tip the balance in a major way, with the largest zone optimally developed in what might be called the traditional analysis but preserved when option value is taken into account.
Anthony C. Fisher

Chapter 5. Resources, Growth and Sustainability

Abstract
This chapter returns to the Malthusian question: are we running out of resources, whether due to population growth or rates of use of both exhaustible and renewable resources. More generally, the question is whether the natural resource base of the economy is adequate to sustain current standards of living. The literature on attempts to estimate measures of resource scarcity at different points in time is reviewed, with some new material, focusing on both physical measures such as reserves, and reserves/production ratios, and economic ones such as costs and prices. The modern statement of the question further broadens the definition of resources used in the production of goods and services (including environmental services as analyzed in the preceding chapter) to include natural capital, contributions of the natural environment such as soils, unpolluted water, and clean air to an inclusive measure of welfare. This in turn leads to the concept of sustainability or sustainable development, first defined in a 1987 report as development that meets the needs of the present without compromising the ability of future generations to meet their own needs. The main thrust of this part of the chapter is to translate this statement into a form suitable for rigorous analysis and ultimately for measurement. This is accomplished first with an intuitive model and then in a more formal one, with much the same results. A very preliminary attempt in the literature at measurement of the sustainability of a number of national economies is reported.
Anthony C. Fisher

Chapter 6. Climate: The Ultimate Resource?

Abstract
The final chapter treats what might be considered a “new” or unconventional resource: global climate, which obviously affects the environment and also underlies the productivity of renewable resources and agriculture. The starting point is a brief discussion of a perceived disconnect between natural scientists and economists on the importance of climate change, with the former believing it to be perhaps the most important environmental problem of the century, requiring prompt and dramatic action and the latter seeing it in less compelling terms—though not all economists are in agreement here. Recent projections by the Intergovernmental Panel on Climate Change (IPCC) are given, with a discussion suggesting these are likely to be conservative in a variety of ways, including neglect of methane feedback, and for a variety of reasons, including the need for consensus among the parties. A discussion of potential impacts focuses on some often neglected and potentially catastrophic, due to tipping points and extreme events, which can in turn lead to major loss of capital (ports, buildings, coastal agriculture, and so on) not well captured in policy models. Given the time scales involved, discounting is of course key. As considered here, the issue boils down to the choice of how the pure (social) rate of time preference in the Ramsey equation should be specified. Two schools of thought are identified. One argues that it is an ethical choice, reflecting relative weights of different generations, and thus exogenous to the economic problem (though this is consistent, in the equation, with a positive discount rate even if the pure rate of time preference is zero). The other school argues that the rate of time preference must be consistent with observed rates of return on investment in private capital markets. Closely related to discounting is the topic of irreversibility, since the world will be locked into a changed climate and its consequences, such as rising sea levels, essentially forever on human time scales. Again there is a split between (some) economists and climate scientists, with the former pointing out that investment in new energy sources and facilities is also irreversible, and might dominate under certain circumstances. The discussion here focuses on a comparison of time scales associated with the two types of irreversibility. Finally, implications for policy are briefly discussed, including the advantages of a carbon tax, but also a potential problem: to achieve a desired objective the tax might have to be unrealistically high. In this case it might be supplemented by a negative tax in the form of a tax credit on energy conservation and renewables, though this can be distortionary (favors one energy source or technology over another). Some attention is also given to the role of public investment in basic research into innovative technologies that do not involve the emission of greenhouse gases.
Anthony C. Fisher

Backmatter

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