Lecture Note, Natural Resource and Environmental Economics Chapter four-Optimal Utilization of NR

CHAPTER FOUR
OPTIMAL UTILIZATION OF NATURAL RESOURCES

4.1. Classification of Resources

Natural resources are broadly classified in to two: Renewable and Non renewable
resources.

Renewable Resources:
- are those which exhibit economically significant rates of regeneration
- their rate of regeneration should be seen in short period of time.
- Natural replenishment augments the flow of renewable resources at a non
negligible rate.
There are two broad of renewable resources: Renewable energy flow Resources and
Renewable but exhaustible stock resources
Renewable but exhaustible stock resources:
- Their continuation and volume of their flow depends crucially on humans.
- They are use dependent(i.e., significantly affected by human activity)
e.g. fishery, wild life, forests
- Improper use of these resources will lead to extinction of the resources.
* soil erosion and nutrient depletion reduce the flow of food.
*fishing reduces the stock of fish, which in turn reduce the rate of natural increase
of the fish population.
Note that the size of the fish depends on
1. biological factor- reproductivity
2. Human action- level of utilization of the fish
Therefore, use dependent resources need to be effectively managed
Renewable energy flow resources:
- the flow is independent of humans
- the amount consumed by one generation does not reduce the amount that can be
consumed by subsequent generations.
E.g. solar energy, wind energy

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Lecture Note, Natural Resource and Environmental Economics Chapter four-Optimal Utilization of NR

Essential features of Renewable Resources

1. its stock can be increased or decrease
it will increase if the stock is allowed to regenerate however there is a maximum
stock. i.e., no renewable resource can regenerate to the level above the carrying
capacity of the ecosystem
2. renewable resources can be disappeared if the rate of harvest exceeds the rate of
natural growth rate of resources

Non Renewable resources

- are those which do not exhibit economically significant rate of regeneration
- are those quantity tend to be fixed for a fairly period of time (hundreds of years).

e.g. Gold, Copper

sock

SS

Time

- are whose potential resources can be exhausted.

- The depletion rate is affected by the demand for and the durability of the
products built with the resources and the availability to reuse the products
9 Except where demand is totally price inelastic, higher price tend to
reduce the quantity demand.
9 Durable product last longer, reducing the need for newer ones
9 Reusable products provide a substitute for new products
- their current resources can be augmented by economic replenishment as well
as by recycling
™ economic replenishment takes many forms all sharing the
characteristics that they turn previously unrecoverable resources in to
recoverable ones. One obvious stimulant for this replenishment is
price.
As P increases – producers explore more widely, dig more deeply, use
lower concentration ores.

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Increase of price stimulate technological progress i.e. doing st which

were not possible before. E.g., nuclear power.

Three separate concepts are used to classify the stock of depletable resources: (1) current
reserves (2) potential reserves (3) resource endowments
* Current Reserves: is the total quantity 9stock) of known resources can profitably be
extracted at current prices.
- the magnitude of these current reserves can be expressed as a number.
If you have part of that resource which can not profitably exploited, it is not part of the
current reserve.
* Potential Reserve: is the resource that you can potentially extract.
- the amount of resource potentially available depend up on the price people are
willing to pay for those resources- the higher the price the larger the potential
reserve
- are most accurately defined as a function rather than a number
Q = f(P)
* Resource Endowment: represent the natural occurrence of resource in the earth’s crust
9 since prices have nothing to do with the size of the resource endowment, it is a
geological rather than an economic concept.
9 It represent the upper limit on the availability of terrestrial resources

Recyclable Resources
9 Are those which, although currently being used for some particular purposes,
exists in a form allowing its mass to be recovered once that purpose is no longer
necessary or desirable.
E,g. Metal –used in certain vehicle and ---
9 Not all resources are recyclable. E.g. petroleum, gasoline- once it burns it change
to other form.

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Lecture Note, Natural Resource and Environmental Economics Chapter four-Optimal Utilization of NR

4.2 Measuring Resource Scarcity

Criteria for an ideal scarcity indicator:

1. For sight
2. Comparability
3. Computability
For sight- the indicator should be forward looking
Comparability-it should enable us to compare availability of resource with another(or
with its substitute) and it should enable us not only the scarcity of the resource but also its
seriousness
Computability- enable us to see the balance of the resource.

Possible Measures of Resource Scarcity

1. Reserve- to-use ratio (a physical indicator):

Stock

Consumption

9 If consumption is per year this ratio indicates the time that is left until the
resource is depleted. If the ratio is 30 it means that with the current consumption
rate 30 years is left for the resource to be depleted.
9 there is no economics in it.

2. Real resource price:

We could use price as indicator of scarcity. But if you want to use price as a measure of
scarcity, you will be advised to use the real price.
Price tell us a number of things. If the real price of the resource increases over time, it
implies the resource becomes more and more scarce. Change in price over time is an
indicator of the supply of that good.
Price also reflects the effect of different variables on the resource.
- existence and status of substitutes and complements.

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- Technological progress
Although price is a best measure, it has some problems.
Some times price may not reflect the scarcity of the resource. This is true under the
following situations.
- price control- lead to artificial prices so we could not use prices as a measure of
scarcity
- subsidy-if government subsidize, prices becomes low not because the resource is
cheap but it is subsidized.
Under such situations price do not tell us the scarcity of the resource.
Price is a good indicator of scarcity when we have competitive market.

3. Marginal Scarcity Rent (MSR)

MSR= Price – Marginal Extraction Cost (MEC)
It can be used as an indicator of scarcity because we have a price; what happens to price
could be reflected and MEC could also tell us about scarcity of resource.
We could expect MSR to increase as resource become more and more scarce.
The problem with this method is that measurement of price is not easy.

4. Marginal Discovery Cost (MDC)

This is the marginal cost concept related to discovering. It is the marginal cost of
discovering resource.
The additional cost of discovery will tell you the scarcity of resource.
It could be an easier measure- collect data on the discovery cost.

5. Marginal Extraction Cost (MEC)

It is the additional cost of extracting a unit of resource.
As the resource becomes more and more scarce, we will expect MEC to increase because
as we extract more and more of non renewable resource, we go deep to get some more
resource which in turn increases cost of extraction.

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Lecture Note, Natural Resource and Environmental Economics Chapter four-Optimal Utilization of NR

4.3 Theory of Optimal Depletion: Case of Non Renewable Resources

We know that non renewable resources are fixed resources, and when we exploit more
and more the amount of natural resource decline. Then the question is how do we
optimally deplete non renewable resources. Because allocation over time is the crucial
issue, dynamic efficiency becomes the core concept. The dynamic efficiency criteria
assumes that society’s objective is to maximize the present value of the net benefits
coming from the resource. For depletable, non recyclable resource, this requires a
balancing of the current and subsequent uses of the resources.

Resource utilization under different scenarios

Case 1: MEC is constant.

The two period model revisited
In the last chapter, we have developed the simple model of resource allocation over two
periods. Assumed in the analysis were:
1. resources are extracted at constant marginal cost , and
2. stable demand curve for the resource.
The observations were:
1. efficient allocation results in more than half of the resource were allocated to the
first period and less than half of it to the second period
2. the allocation was affected by marginal cost of extraction and by the marginal
user cost.
3. the marginal cost off extraction is assumed to be constant, but the current value of
the marginal user cost rises over time;
4. the rate of increase in the marginal user cost is equal to r, the discount rate.
- MUC2 = (1+r)MUC1
The marginal user cost rises at rate r in an efficient allocation in order to
preserve the balance between the present and future production.
Note: Due to the fixed and finite supplies of depletable resources, production of a unit
today precludes production of that unit tomorrow. Therefore production decisions today

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must take foregone future net benefits in to account. Marginal user cost is the opportunity
cost measure that allows balancing to take place.

In summery, our two period example suggests that an efficient allocation of a finite
resource with a constant marginal cost of extraction involves rising marginal user cost
and falling quantities consumed.

The N- Period Constant cost case

This is the extension of the two period model by extending the time horizon with which
the resource is allocated. The two assumptions of the former model are retained.
The following generalizations can be made from the model.
1. in spite of the fact that marginal cost of extraction remains constant, the efficient
marginal user cost rises steadily. This rise in the efficient MUC reflects increasing
scarcity and the accompanying rise in the opportunity cost of current
consumption.
2. in response to a rising costs over time, the quantity extracted falls over time until
it finally goes to zero. At this point, total marginal cost is equal to the highest
price any one is willing to pay, so demand and supply simultaneously equal to
zero.
MC(per unit
extracted)
Quantity extracted

Total marginal cost (TMC)

& consumed

T* Time
T* Time
b) Marginal cost profile
a) Quantity profile

Note: TMC =MUC + MEC

MUC = TMC + MEC MUC1 < MUC2 => p1 < p2
= P – MEC but their present value is equal.
= MNB

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P(t)
P(t) P(t)=trend in the price of the resource
P0=initial price
R0=initial quantity
DD=demand

DD

T (Time)
R (Quantity
demanded)
R(t)

T (Time)

Case 2: Transition to Substitutes

The transition to substitute could be from

- depletable to renewable resources
- depletable to another depletable resources

a) Transition from one constant marginal cost depletable resource to a renewable

resource:
E.g. Oil (or natural gas) with a solar substitute
Exhaustible ground water with a surface water substitute
How do we define an effective allocation in this circumstance?
In this case depletable resource would be exhausted, but that will be less of a problem,
since we will merely switch to the renewable one at thee appropriate time. Suppose that a
perfect substitute for the depletable resource is infinitely available at a cost of $6 per unit.

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- The transition from the depletable to renewable resource would ultimately transpire
because its MC($6) less than the maximum WTP($8)
- The TMC for depletable resource never exceed $6 because society could always use
the renewable resource instead, whenever it was cheaper.
Thus, while the maximum WTP sets the upper limit on the TMC when no substitute is
available, the MC of extraction of substitute sets the upper limit when one is available at
MC lower than the maximum WTP.
Quantity Extracted
& consumed

MC

TMC
Consumption of depletable plus $6
Renewable Resources

Extraction and Consumption of

depletable Resources MEC

6
7 Time
Time

Note:
- in this efficient allocation quantity extracted is gradually reduced as the marginal
user cost rises until switch is made to the substitute.
- Depletable resources would be exhausted sooner than iht would have been
without the renewable resource substitute.
- Prior to switch (transition) point, only the depletable resource is consumed, while
after the switch point only the renewable resource is consumed. This sequence of
consumption pattern results from the cost patterns.

b) Transition to another depletable substitute Resources

Assume that the transition is from one constant MC depletable resource to another
depletable resources with a constant but higher MC. Here, initially the first resource is

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cheaper but its marginal cost would rise over time until it equaled that of the second
resources at the time of Transition (T*). Before the transition, only the first resource is
consumed (because it is cheaper) and unfortunately all of it would have been consumed
by T*.

TMC2
TMC1
Price or
Cost ($per
unit

MEC2

MEC1

0 T* Time

The marginal cost path reveals the following characteristics.

1. the transition is smooth one; total MC never jumps to higher level.
The TMCs are equal only at the transition period. In the period before T*, the first
resource is cheap and therefore used exclusively where as after transition, the first
resource is exhausted leaving only the second resource.
2. the rate of increase in TMC slows down after the time of transition.
This is because the component of TMC that is growing (the MUC) represents a
smaller portion of TMC of the second resources than of the first.
In both cases the MUC increases at rate r, and the MEC is constant. At the time of
transition the MEC which is constitute a much larger proportion of TMC from the
second resources than from the first. Hence, TMC rises more slowly from the
second resources at least initially.
It should be noted that MUC is always positive for depletable resources because using
these resources reduces the net benefits received by the future generation.=> MUC for
non depletable resources is zero.

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Case 3: Increasing MEC

This is a situation in which the marginal cost of extracting the depletable resources rise
with a cumulative amount extracted. This is more realistic case, for example, with
minerals, where the higher grade ores are extracted first followed by an increasing
reliance on lower grade ones.
The dynamic efficient allocation of this resource is found by maximizing the PV of the
NBs using the modified cost of extraction function.
Quantity Extracted
& consumed

MC
Extraction and
Consumption of depletable
($ per unit)
TMC
$6
Consumption of depletable
plus Renewable Resources

Switch
point MEC

7
Time
7 Time

a) Quantity Profile b) Marginal Cost Profile

Note the behavior of the MUC. In the previous case, we said that MUC rose over time at
rate r. when the MEC increases with the cumulative amount extracted, MUC declines
over tome until, at the time of transition to the renewable resource, it goes to zero. Why is
that?
Remember that MUC is an opportunity cost reflecting forgone future marginal net
benefit. In contrast to the constant MC case, every unit extracted raises the cost of
extraction. Therefore, as the current MC rises over time, the sacrifice made by future
generations (as an additional unit is consumed earlier) diminishes; the net benefit that
would be received by future generation if a unit of the resource were saved for them gets

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smaller and smaller as the marginal extraction cost of that resource gets larger and larger.
By the last period the MEC is so high that earlier consumption of one more unit imposes
virtually no sacrifice at all. The opportunity cost of current extraction drops to zero, and
TMC equals the MEC at the switch point.
Note also that in the constant cost case, the depletable resource reserve is completely
exhausted. In the increasing cost case, however, the reserve is not exhausted; some is left
in the ground because it is too expensive to take out.

Exploration and Technological Progress

The model considered to this point have not yet included a consideration of the ole of
technological progress, historically two significant factors in the determination of actual
consumption paths.
As easily discovered resources are exhausted, we must search in less rewarding
environments, such as the bottom of the ocean or locations deep within the earth. This
suggests the marginal cost of exploration, which is the marginal cost of finding additional
units of the resource, should be expected to rise over time, just as the marginal cost of
extraction does. The higher the marginal cost of extraction for known resources is
expected to rise, the larger is the potential increase in net benefits from exploration.
Compared to a situation with no exploration possible, the model with exploration would
show a smaller and a slower decline in consumption, while the rise in TMC would be
dampened.

Depletable, Non recyclable energy resources

Energy is one of he most critical resources; without it life would cease. We derive energy
from the food we eat, from the sun, and from the earth’s crust. Depletable and non
recyclable energy resources include, oil, gas, coal and uranium. Currently most
industrialized countries depends on oil, natural gas for most of their energy needs.
According to depletable resource models, oil and natural gas would be used until the
marginal cost of further use exceeds the marginal cost of substitute resources- either more
abundant depletable resources, such as coal, or renewable resources, such as solar energy.
In an efficient market path, the transition to these alternative sources would be smooth

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and harmonious. However, experiences from different angles of the world reveals that the
allocation of these resources are not left for the market.
a. Price controls: e.g natural gas
In many countries (both developed and developing ones), the price of natural resources
(such as natural gas) are determined by the administrative bodies. Government usually
put a price ceiling on the market. The ceiling would prevent prices from reaching their
normal levels. Consequently, customers who had contracted and were willing to pay for
natural gas were unable to get as much as they want. Since price increase are the source
of the incentive to conserve, the lower prices would cause more of the resource to be used
in the earlier years. Consumption levels in those years would be higher under price
controls than without them.
Effects on the supply side are also significant. Producers would produce the resource only
when they could do so profitably. Once the marginal cost rose to meet the price ceiling,
no more would be produced, in spite of the large demand for the resource at that price.
Thus, as long as price controls are permanent, less of the resource would be reduced with
controls than without. Furthermore, more of what would be produced would be used in
the earlier years.
The combined impact of these demand and supply effects would be to distort the
allocation significantly. While a number of aspects differentiate this allocation from an
efficient one, two are of particular importance:
i. The time of transition is earlier under the price controls. This means we would not
be using all of the natural gas available at prices consumers are willing to pay.
Among other things this could cause a transition to a substitute before the
technologies to use it were adequately developed, which can place quite a burden
on consumers.
ii. The transition is abrupt/unexpected, or quick, with prices suddenly jumping to new
higher levels.
The following diagram shows the trend of quantity and prices in the increasing
marginal extraction cost with substitute resources in the presence of price controls.

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Quantity Price($
extracted per unit)

Switch
Point
P(t)

MC(t)

Time Time

a) Quantity profile. b) Price profile

Why did the government embark on such a counterproductive policy?

The answer is found in rent seeking behavior which can be explained through the use
of consumer and producer surplus model. In the present of price ceiling, producers
supply more of the resource that what would be supplied by the market.
Consequently, there will consumer surplus than would be. Because producers would
be overproducing, they would be giving up the scarcity rent they could have gotten
without price controls. Some future consumers, meanwhile, are also worse off. Since
the supplies are exhausted more rapidly, the switch to the more expensive substitute
is made prematurely, and hence, higher prices are experienced by future consumers.
This is actually how government gains political gain as the policy transfers resources
from the future consumers to the present consumers. Markets in the presence of price
controls are indeed myopic, but the problem lies with the controls, not the market.
Thus, over the long run price controls end up harming consumers rather than helping
them.

b. The Cartel Problem

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4.4 Theory of Optimal Use: Case of Renewable Resources

Renewable resources are those for which the stock can be continually replenished. It is
easy to think of renewable resources as perpetual. They have a capacity to replenish or
regenerate. They are those that have significant rate of regeneration. i.e. for a renewable
resource, growth or flux is assumed to take place at “a significant rate” when viewed
from man’s economic time scale. E.g. if red wood trees regenerate, but at an insignificant
rate, they might be regarded as a non renewable resources.

However, some renewable resources- living populations, such as plants and animals- are
also exhaustible if not managed effectively. The growth or decline of these populations
in general depends on the size of the population. If through human activity, the
population is drawn down beyond the crucial threshold, the species can become extinct.
This is of curse one of the crucial renewable resource management issue.
On the other hand biological populations belong to a class of renewable resources (use
dependent ones), wherein the size of the resource stock (population) is determined jointly
by biological considerations and by actions taken by society. The size of the population,
in turn, determines the availability of the resources for the future. Thus humanity’s
actions determine the flow of these resources over time. Since this flow is not purely a
natural phenomenon, a second crucial dimension is the optimum rate of use across time
and across generations. What is the efficient rate of use of use dependant renewable
resources? In the absence of outside influences, can the market be relied upon to achieve
and sustain this rate?

General Characteristics of Renewable Resources

→ They have the capacity for reproduction and growth; e.g. plant or animal population
→ The are also inanimate mass or energy sources subject to constant or periodic inflaw;
e.g. water, wind, or solar radiation

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A. Forests
Forests represent an example of storable, renewable resources. They provide a variety of
products and services. Forests
♣ Serve as raw material for housing and wood products such as paper products.
♣ Serve as an important source of fuel.
♣ Cleans the air by absorbing CO2
♣ Shelter for wild life.
♣ Maintain the watersheds.
Despite all these benefits, a glance at some of the vital signs of the forest resource does
not inspire confidence that is being managed either efficiently or sustainably.
Deforestation is currently proceeding at an unprecedented rate. In 1992 the World
Resource Institute reported that 42 million acres of tropical forests are being destroyed
each year as trees are cut for timber and for clearing land for agriculture and
development.
Deforestation is a serious problem because it has intensified global warming, has
decreased biodiversity, has caused agricultural productivity to decline, has increased soil
erosion and desertification, and has precipitated the decline of traditional cultures of
people indigenous to forests.
Timber shares with many other animate resources the characteristics that it is both an
output and a capital good. Trees, when harvested, provide a salable commodity, but left
standing they are a capital good, providing for increased growth the following year. As
trees mature very slowly, the manager must decide not only how to maximize yields on a
given amount of land, but also when to harvest and replant.

Defining Efficient Management

Biological Dimension:
Trees growth is measured on a volume basis, typically cubic feet, on a particular site.
Based on this measurement of volume, the data reveal that tree stands go through distinct
growth paths. Initially, when the trees are very young, growth is rather slow in volume
terms. A period of sustained, rapid growth follows with the volume increasing

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considerably. Finally, slower growth sets in as the stand fully matures, until growth stops
or even reverses.

Volume
(Cubic Feet)

0 Years

When should this stand be harvested? Foresters have come up with a calculation called
the Mean Annual Increment (MIE) which provides the bases for a biological approach to
answering this question.
MIE is calculated by dividing the cumulative volume of the stand at the end of each
decade by the cumulative number of years the stand has been grown up to the decade.
According to the biological decision rule, the forests should be harvested at the age when
the MIE is maximized.
The Economics of Forest Harvesting:
To an economist, this biological criterion seems rather arbitrary; it fails to consider any of
the factors such as the value of the timber, the time value of money, or costs associated
with planting and harvesting which would play a central role in an efficient harvesting
decision. It is, however possible to use the basic biological model of growth portrayed
above as a basis for an economic model of harvesting decision.
Form the definition of efficiency, the optimal time to harvest this stand would be that
time which maximizes the present value of the net benefits from the wood. The size of
the net benefits from the wood depends on whether the land will be perpetually
committed to forestry or left to natural process after harvest. To start with assume that the
stand will be harvested once and the land will be left as is following the harvest.
Two costs are presumed to be important in this decision-planting costs and harvesting
costs. Apart from their magnitudes, these costs differ in one significant characterstic-the

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time at which they are born. Planting costs are born immediately, while harvesting costs
are born at the time of harvest. In present value calculation, harvesting costs are
discounted because they are paid in the future whereas planting costs are not discounted
because they are paid immediately.
Some interesting conclusions can be made from the economic harvesting decision.
First, discounting shortens the time until the stand is harvested. Higher discount rates
imply shorter harvesting periods because they are less tolerant of the slow growth of
timber that occurs as the stand reaches maturity.
Second, changing the magnitude of the planting and harvesting costs does not change the
optimal harvesting point.
What would be the effect of a t tax levied on each cubic foot of wood harvested in this
simple model? Since this tax would raise the marginal cost of harvesting by an amount of
t, it would have the same effect as a rise in harvesting cost; it would also leave the
optimal harvesting age unchanged.
This model can be extended to the more advanced and realistic one by incorporating the
concepts of opportunity costs, and relaxing the assumptions of -------.

Sources of Inefficiency
The rather harmonious view of a regulated forests conveyed by these models contrasts
rather sharply with the reality of rapid deforestation. Why are forests being harvested so
rapidly, in apparent violation of both efficiency and sustainability criteria?
a. Global inefficiencies
The first source of deforestation involves external costs that transcend national
borders. Because the costs transcend national borders, it is unrealistic to expect
national policy to solve the problem. Some international policies such as
preservation of biodiversity and reduction of global warming would normally be
necessary.
b. Poverty and debt
Poverty and debt are also major sources of pressure on the forest. Peasants see
unclaimed forest land as an opportunity to become land owners. Nations
confronted with masses of peasants see unowned or publicly owned forests as a

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politically more viable source of land for the landless than taking it forcibly from
the rich. It is also found that poverty and deforestation creates a vicious circle in
which they reinforce each other.
The large debts owed by many developing countries also encourage these
countries to overexploit their resource endowments to raise the necessary foreign
exchange.
c. Perverse incentives
Profit maximization does not produce efficient outcomes when the pattern of
incentives facing decision-makers is perverse. Forestry provides an unfortunately
large numbers of situations where perverse incentives have produced very
inefficient and unsustainable outcomes.
Can perscistent private owners be counted up on to manage efficiently? For
forests dedicated to timber harvesting, profit maximization can be compatable
with efficient management. As long as social and private discount rates are the
same and price expectations are accurate, the rotation which maximizes profit will
also maximize net benefits. Both shorter-than-efficient rotations and longer-than-
efficient rotations would result in lower profits, so it is in the self interest of the
private owner to act efficiently. Thus, profit maximization can be compatible with
efficient forest management under the right circumstances. In particular, profit
maximizing private owners have an incentive to adopt the efficient rotation (when
amenity services are small) and to undertake investments which increase the yield
of the forest.
In reality, not all private firms will follow efficient forest management practices
because they may choose not to maximize profits, they may be operating at too
small a scale of operation, or externalities may create inefficient incentives. In
addition the price expectations which motivate private harvesting behavior may
not be accurate. To the extent that forest owners incorrectly anticipate future
prices, their decisions will not be accurate.
Inefficient deforestation has been encouraged by a failure to incorporate global
benefits from standing forests, by concession agreements which provide

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incentives to harvest too much, too soon, and which fail to provide adequate
incentives to protect the interest of the future generations.

Implementing Efficient Management

Does ownership of forest by a government provide an answer? With the large amenities
of resource at its disposal, plus the ability to acquire land through eminent domain
proceedings, the government can achieve the efficient scale rather easily. Furthermore,
since it is not obligated to maximize profits, it can more easily take external effects on
wild life or recreation in to account. However, it is practically observed (even in USA)
that the management of public forests has not yet reached the point where it yields
efficient outcomes. Other policy approaches offer the prospect of a more rapid transition
to efficiency.
One such approach involves restoring efficient incentives – concessionaries should pay
the full cost for the rights to harvest publicly controlled lands, including compensating for
damages to the forest surrounding the trees of interest.
Another approach involves enlisting the power of consumers in the cause of sustainable
forestry. The process typically involves the establishment of standards for sustainable
forestry, employing independent certifiers to verify compliance (conformity) with these
standards, and allowing certified suppliers to display a label designating compliance.
Effectiveness of this approach requires a) consumers must trust the certification process;
b) consumers must be concerned about sustainable forestry to pay a price premium that is
large enough to make certification an attractive option for forestry companies.
Most of these changes could be implemented by individual nations to protect their own
forests. But what about the global inefficiencies?
Several economic strategies exist. They share the characteristic that they all involve
compensating the nations conferring external benefits so as to encourage conservation
actions consistent with global efficiency.
Debt-Nature Swaps: One of the more innovative policies that explores common ground in
international arrangements has become known as the debt-nature swap. It involves
reducing the pressure on the forests caused by the international debt owed by many
developing countries. In this approach non governmental environmental organization

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purchase the developing country debt. The new holder of the debt, the NGO, offers to
cancel the debt in return for environmentally related action on the part of the debtor
nation. (E.g. the of 1987 purchase of $650,000 Bolivia’s foreign debt by an American
environmental organization from a private bank at a discounted value of $100, 000.)
The main advantage these arrangements to the debtor nation is that a significant foreign
exchange obligation can be paid off with domestic currency. Debt-nature swaps offer the
realistic possibility to turn what has been a major force for unsustainable economic
activity (debt crises) in to a force for resource conservation.
Extractive Reserves: One strategy designed to protect the indigenous people of the forest
as well as to prevent deforestation involves the establishment of extractive reserves.
These areas would be reserved for the indigenous people to engage in the traditional
hunting-gathering activities. E.g. it is practiced in the Acre region of Brazil.
Establishing Conservation Easements: A common global fund could be established to
receive and dispense revenue raised in the industrialized nations for the purpose of
protecting biodiversity in ecologically viable sites.
Royalty Payments: It is a principle entitles that nations containing biologically rich
resources (of flora and fauna that are used in pharmaceutical industry) within their
boundaries to stipulate royalty on any and all products developed from the genes obtained
from these preserves. These arrangements are particularly significant because they
facilitate transboundary sharing of the costs of preservation. It is unrealistic to expect that
countries harboring these preserves should be expected to shoulder the entire cost of
preservation when the richer countries of the world are the major beneficiaries.

Debt-nature swaps, extractive reserves, royality payments, and conservation easements

all involve a recognition of the fact that resolving the global externalities component of
deforestation requires a rather different approach from resolving the other aspects of the
deforestation problem. In general, this approach involves financial transfer from the
industrialized nations to the tropical nations, transfers which are constructed so as to
incorporate global interests in to decisions about the futures of tropical forests.

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B) Fish

Growth functions: The Biological Dimension1

The biological characterization of the fishery rests on a model initially proposed by
Schaefer (1957). Schaefer model points a particular average relationship between the
growth of the fish population and the size of the fish population.

Suppose that we have a biological resource stock, whose size at time t is denoted by Xt,
in discrete time or X(t), in continuous time.
In the absence of harvesting, the dynamics of the resource stock can be described by the
equation:
Xt+1 – Xt = f(Xt)
It can also be described by the differential equation:
dX (t ) •
= X = f ( X (t ))
dt
These equations simply say that change in the resource stock depends on the current
stock size (Xt or X(t)). This growth is said to be density dependent.

The growth function, f(Xt), is defined over the interval X ≥ 0, and it is usually assumed
that there exists two values XL < XU for which the following is true.

≤ 0; 0 < X ≤ XL

f(Xt) > 0; XL < Xt < XU

< 0; Xt ≥ XU

Where; XU = upper limit of x

1
The mathematical part is from Mupimpila, Christopher, 2004. Lecture Note offered at JFE program,
Nairobi-Kenya.

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XL = lower limit of X
Xt = value of X in t.
Alternatively, these properties of f(Xt) may be stated as
f(X) < 0 if 0 < X ≤ X
f(X) > 0 if X < X ≤ X
f(X) < 0 if X ≤ X
where; X =XU= upper limit
X= XL= lower limit

Graphically,

Growth
of X

F(Xt)

0 XL XU

Population of X

The size of the population is represented on the horizontal axis and the growth of the
population on the vertical axis. The graph suggests that there is arrange of population
sizes (XL to X*) where population growth increases as the population increases and a
range (X* to XU) where initial increases in population lead to eventual declines in groeth.

Note
9 At XL and XU, the function intersects the horizontal axis which means the growth
in the stock is zero.

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9 S* is known as natural equilibrium, since is population size which would persist

in the absence of outside influences. Here, reduction of the stock exactly offset by
increase in the stock. Note also that this natural equilibrium would persist because
it is stable. A stable equilibrium is one which movements away from this
population level set forces in motion to restore
o If the stock exceeds X*, it would be exceeding the capacity of the habitat
(called carrying capacity). Hence, mortality or out migration would
increases until ---.
o If the stock is less than X*, the stock will be smaller, and hence growth
would be positive and the size of the stock would increase.
9 XL is known as the minimum viable population, which represents the level of
population below which growth in population is negative. Here the equilibrium is
unstable
o Population size below XL lead to positive growth and a movement along
the curve to X* and away from XL.
o When population moves to the left of XL, the population declines until it
eventually becomes extinct. In this region no force act to return the
population to a viable level.
9 A catch level is said to represent a sustained yield whenever it equals the growth
rate of population, since it can be maintained forever. As long as the population
size remains constant, the growth rate (and hence the catch) will remain constant
as well.
9 X* is known in biology as the maximum sustainable yield population, defined as
that population size which yields the maximum growth ;hence the maximum
sustainable yield is equal to its maximum growth and it represents the largest
catch that can be perpetually sustained.

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Depending on the values of XL and the characteristics of f(Xt), we have three cases
growth functions:
Case 1- XL = 0 and f(Xt) is strictly concave
f ( x)
For such a growth function the relative growth rate r ( X ) = is a decreasing function
x
of X. i.e. f” X < 0.
This growth function is said to be purely compensatory.

Growth
of X
F’’X<0
f(Xt)

0 XL XU
Population of X

Case 2- XL = 0 and f(Xt) is initially convex and then concave

This is the case where the growth function has an inflection point. This growth function is
said to be depensatory.

Growth
Graphically, of X

F(Xt)

0 XL XU

Population of X

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Case 3- XL > 0 and f(Xt) is initially convex and then concave

This growth function is called a critical depensation and XL is called the minimum viable
population.

Growth
of X

F(Xt)

0 XL XU

Population of X

XU = environmental carrying capacity2

Specific form of growth functions

There are many possible functional specifications for f(Xt). The best known are:
i. The Logistic growth Model
ii. The Gompertz Growth model
i. The Logistic growth Model
This model was first proposed in 1830 by P. F. Verhust in relation to human population.
When written as a differential equation, the logistic growth model takes the following
form:
•
⎡ X (t ) ⎤
X = f ( X (t )) = rX (t ) ⎢1 −
⎣ k ⎥⎦
Where; r= the growth rate of the resource X, or the intrinsic growth rate

2
Culling- killing when the elephant number exceeds the carrying capacity of the park. E.g. it is being
practiced in South Africa.

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K= the environmental carrying capacity, or saturation level.

Specified in this manner, the logistic equation is purely compensatory.
i.e. XL = 0,
f(X(t)) is strictly concave, and
XU = k, is a globally stable equilibrium.
X(t)→k from any X(0)>0 as t→∞
i.e. lim X (t ) = k , provided that X (0) > 0
t →∞

Graphically,

Growth
of X

⎡ X⎤
f (X) = rX⎢1− ⎥
⎣ k⎦

0 XL=0 XU=k
Population of X

Alternatively,

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The Gompertz Growth Function

When written as differential equation, the Gompertz function takes the form:
• ⎡ k ⎤
X = f ( X (t )) = rX (t ) ln ⎢ ⎥
⎣ X (t ) ⎦
Where; r= the growth rate of the resource X, or the intrinsic growth rate
K= the environmental carrying capacity, or saturation level.

Limitations of these growth models

1. These models do not indicate the stochastic nature of the problem (EL-Nino
effect) or the age and sex distribution of the population.
2. the models do not show Computing or Complementary species.3

Production and Yield Functions

i. Harvest (or Yield)

When a resource is harvested, it is assumed that the rate of harvest is a function of the
economic inputs devoted to the harvesting and of the available stock.
i.e. Y(t) = H(E(t), X(t)) -------------------------------------------------(1)
where; Y(t)=the production function or rate of harvest (measured in the same unit as X(t))
X(t)=resource stock (such as forests fish, wild life, etc).
E(t)=effort; i.e. aggregate measure of various inputs (or economic inputs that we
use for harvesting). E.g. the number of vessel or days devoted to fishing
during the particular year.
A production function commonly used in fishing management is
Y(t) = qE(t).X(t), where q is constant.
The discrete time analogue is Yt = X t (1 - e -qE t )
Assumptions used in this function are

3
For the modified model See Mipumpila’s Lecture Note.

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9 Catch per nit effort (Y/E) is directly proportional to the density of the
fish in the sea.
9 The density of the fish is directly proportional to the abundance X(t).

If these assumptions are thought to be unrealistic, a more general form of production

function may be preferred such as
Y(t) = qE(t)αX(t)β

ii. Rate of Growth of Resource stock

With harvesting, the rate of growth (or change) in the resource stock must reflect
a. the resource stock, f(X(t)),
b. the harvest, Y(t).
Thus we have
X t +1 − X t = f ( x t ) − Yt
•
and X = f ( xt ) − Yt ------------------------------------------------------------------(2).
•
This simply states that the growth in the resource, X , is a function of the resource stock,
f(X(t)), minus the rate of harvest, Y(t).
•
Note that without harvesting, equation 2 becomes simply X = f ( xt ) .

iii. Sustained Yield Function

By sustained yield function, we mean that X, Y, and E all remain constant over time.
Therefore, the sustained yield function is an equilibrium concept expressing sustainable
harvest (yield) as a function of effort.
From equations (1) and (2), we obtain
•
X = f ( x) − Y = 0 ------------------------------------------------------------------ (3).
•
Since X, Y, and E are constant, X = 0
Y = H(E, X)-------------------------------------------------------------------------(4).

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Eliminating X from (3) and (4), gives the sustained yield function
Y = (E) ------------------------------------------------------------------------------ (5).

Suppose we have the logistic function of the form

•
⎡ X (t ) ⎤
X = f ( X (t )) = rX (t ) ⎢1 − ----------------------------------------------------------- (6).
⎣ k ⎥⎦

Using the information given in equations (3), (6), and (7) it can be proved4 that the
sustained yield function will be
Y = qEX
qE
Y = qEk (1 − ) ---------------------------------------------------------------------(11).
r
This is the Schaefer-Fisheries model and is also called Yield-Effort Function. (It is the
combination of logistic growth model and the yield function.)

In equation (11),
qE= relative rate of harvest
r= intrinsic (natural) rate of growth of the fish stock.
Note that if qE=r, the Y=0.
Interpretation of the above statement:
In equation (11), if the relative rate of harvest-(qE) exceeds the rate of growth of the fish
stock-(r), then the population will be driven to extinction and the yield become zero.

The Yield Effort Curve

The yield effort curve is a concave or bell shaped curve that describes the amount of a
given resource harvested in relation to effort.
It is proved that the yield rises, reaches a maximum and then begins to decline as effort
increases. Eventually, the yield becomes zero and the renewable resources may be driven
to extinction because the rate of harvest exceeds the rate of generation of the resource
sock.

4
For the detail of the prove please refer to -------------or Christopher Mipumpila’s Lecture note.

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Yield,
Y(t) Yield-Effort Curve

qE
Y = qEk (1 − )
r

0
Effort, E(t)

Note that the yield effort curve is different from the growth function (in both of its
variables on the X-Y plane).

Concluding Remark:
One of the critical issues in the optimal utilization of renewable resources is that,
although the resources are renewable, they can be depleted if the rate of harvest exceeds
the rate of regeneration of the resource stock.

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Management of Renewable Resources: A comparison between three Models

The principles of the optimal use of renewable resources are often derived from
comparing three types of equilibria.
i. the maximum sustainable yield (or biological optimum)
ii. the competitive (economic) optimum
iii. the common property resource equilibrium (i.e. free access).

Graphically:

dTR
MR =
Tones dE
of fish TC

TR

0 E* EMSY E∞ Effort, E(t)

Note that the yield-Effort curve is, in essence, the total revenue curve. This is because, it
is from fish harvest that revenue is obtained.
dTR
MR = is the slope of the TR curve.
dE
The TC curve depicts the total cost curve; representing the cost of fishing, such as wages
and salaries, capital costs, and so on. The TC is directly proportional to effort (economic
inputs) because the more the effort, the more the cost of fishing.
Since the TC isa straight line, the marginal cost is every where coincidental with the TC
line.
dTC
By definition, MC = , slope of the TC curve.
dE

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i. The Maximum Sustainable Yield (MSY)or Biological Optimum

There are two definitions of MSY and these gives rise to two different ways of formally
deriving MSY.
Definition-1: maximum sustainable yield is when the growth rate of a resource reaches a
maximum. It is represented by the highest point on the f(X(t)) curve.
Definition 2: maximum sustainable yield is the highest possible yield without depleting
the resource. It is represented by the highest point on the yield-effort curve
(or TR curve).
Mathematically, there are two ways to obtain the maximum sustainable yield:
i. by maximizing the sustainable yield function Y = f(X) which requires that
f’(X)=0.
ii. By maximizing the sustainable yield function Y=Y(E) which requires that
Y’(E)=0.

Case #1: MSY where Y=f(X) and f’(X)=0

Suppose we have the logistic growth function
•
⎡ X (t ) ⎤
X = f ( X (t )) = rX (t ) ⎢1 − ---------------------------------------------------(1)
⎣ k ⎥⎦

Simplifying, we get
• rX 2 (t )
X = f ( X (t )) = rX (t ) − ----------------------------1’
k

Since we are dealing with sustained yield, we can drop the t notation. And we can write
• rX 2
the above expression as X = f ( X ) = rX − .
k

From 1’,we will get

∂f 2rX
= f '(X ) = r −
∂X k
MSY requires that f’(X)=0
2rX
⇒ f '(X ) = r − =0
k

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Solving for X, we obtain

rk − 2 rX
= 0
k
rk − 2 rX = 0
Simplifying, we get

k
X MSY =
2

Substituting XMSY in to the sustained yield function:

•
X = f (X ) − Y = 0
or
YMSY = f ( X )
X
= rX (1 − )
k
k k/2
= r (1 −
2 k
rk
Y MSY =
4
Graphically,

Growth
of X
•
⎡ X ⎤
X = f ( X ) = rX ⎢1 −
⎣ k ⎥⎦

0 k k
Y MSY = Population of X
2

Note that XMSY is always at half of the environmental carrying capacity

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Case #2: MSY where Y=Y(E) and Y’(E)=0

Consider the sustained yield function
•
X = f (X ) − Y = 0
• X
X = rX (1 − ) −Y
k
Where; Y=qEX
X
⇒ rX (1 − ) =qEX
k
Solving for X, we get:
qE
X = k (1 − )
r
Substituting in to the yield function Y=qEX and solving for Y we obtain
qE
Y = qEk (1 − )
r
Simplifying, we get
q2 E 2k
Y = qEk − )
r
∂Y
To obtain MSY, we get =0
∂E
∂Y 2qE
= qk (1 − =0
∂E r
r
Solving for E, we obtain: E MSY =
2k
Graphically,

Yield,
Y(t)

0 r
E MSY = Effort, E(t)
2k

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Note that at YMSY, the level of effort is greater than at the economic optimum-E*. Clearly
then, the MSY is a suboptimal management strategy.

ii. The Competitive (Economic) Optimum

Based purely on economic considerations, profit maximization occurs at E*, where
MR=MC.
It is important to note that the level of effort is the lowest among the three equilibria
considered here.

Static Efficient Sustained Yield

Is the maximum sustainable yield synonymous with efficiency? The answer is no.
efficiency, it may be remembered, is associated with maximizing the net benefit from the
use of the resource. If we are to define efficient allocation, we must include the cost of
harvesting as well as the benefits.
The static efficient sustainable yield is the catch level which, if maintained perpetually,
would produce the largest annual net benefits. In this analysis three simplifying
assumptions are made.
1. The price of the fish is constant and does not depend on the amount sold;
2. The marginal cost of a unit of fishing effort is constant; and
3. The amount of fish caught per unit of effort expended is proportional to the size
of fish population.
In any sustainable yield, catches, population, effort levels, and net benefits remain
constant over time. The static efficiency sustainable yield allocation maximizes the
constant net benefit.
The net benefit is presented in the diagram as the difference (vertical distance) between
benefits (prices times the quantity caught) and costs (the constant marginal cost of effort
times the unit of effort expended). The efficient level of effort is E*, the point where the
vertical distance between benefits and costs is maximized. At E* the marginal benefit
(which graphically is the lope of the total benefit curve) is equal to marginal cost (the
constant slope of the total cost curve). Now we know why the maximum sustainable yield
is not efficient. It would be efficient if the marginal cost of additional effort were zero.

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Dynamic Efficient Sustainable Yield

The static efficient sustainable yield is the allocation which maximizes the net benefit in
every period. It turns out to be the special case of the dynamic efficient sustainable yield
where the discount rate is zero.
When positive discount rates are introduced, the efficient level of effort would be
increased beyond that suggested by the static efficient sustained yield with a
corresponding decrease in equilibrium position level.
The increase in the yearly effort beyond the efficient sustained yield level would initially
result in an increased net benefit from the increased catch. However, since this catch
exceeds the sustained yield for the population size, the population of fish would be
reduced and future population and catch levels would be lower. Eventually as the level of
effort is maintained, a new lower equilibrium level would be attained when the size of the
catch once again equals the growth of the population. It was mathematically found that as
the discount rate is increased (in terms of the above graph), the dynamic efficient level of
effort is increased until, with an infinite discount rate, it becomes equal to E*, the point at
which net benefits go to zero.

iii. The Common- Property Resource Equilibrium (Free Access)

The common property equilibrium occurs when the net returns are zero. This is E∞,
where TR=TC. Why?
Case 1: for E< E∞,TR>TC which implies there is positive economic profit.
Given free access, there will be an expansion of effort (those in the industry expand
effort, those who are outside the industry inter).
Case 2: E > E∞, TR<TC which implies there are economic losses and therefore a
decrease in effort.
Thus, the common property equilibrium occur at E∞, where TR=TC.
Note that E∞>EMSY>E*
This fact is often referred to as the Tragedy of the Commons.

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The Tragedy of the Commons

Simply stated, the concept of the tragedy of the common states that a common property
resource gets used by every body until it is of no use to no body.

Principles for common property management

It is noted from the above discussions that open-access resources generally violate both
the efficiency and sustainability criteria. If these criteria are to be fulfilled, some
restructuring of the decision making environment is necessary.
Policies designed to solve problems a rising from free access are of two kinds.
i. Assigning exclusive property rights.5
This is allowing some fisheries to be privately rather than commonly held because
inefficiency in management of fishery results from treating it as common, rather
than private, property. This is applicable when the fish are not very mobile, when
they can be confined by artificial barriers etc.

ii. In cases where property rights assignment is not feasible, (e.g. oil pools, aquifers,
fishing waters, wild life, etc) the government can
a. Invest in resources and maintenance; e.g. stocking fishery, disease
prevention, etc.
b. Restrict harvesting (pumping, extraction) by:
i. Giving quotas at the economic optimum, E*
ii. Selling licenses for the output corresponding to economic optimum
iii. Taxing the output at the rate of the difference between MC and AC
at E*.

@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@

5
This approach is quite possible in the case of land ownership.

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