CHAPTER ONE

INTRODUCTION TO NATURAL RESOURCE AND

ENVIRONMENTAL ECONOMICS

1.1. Definition and Concepts of Basic Terms

oEconomics

oNatural resource

oEnvironmental resource
 Definitions and Concepts of basic
terms
Economics is the study of the allocation of scarce resources.
a social science, which studies how societies allocate scarce resources in
the production and distributes of goods and services so as to attain the
maximum fulfillment of society’s material wants.
Note that the theories of economics can be applied to any scarce resource
including natural and environmental resources.
Economics is not simply about profits or money, it applies anywhere
constraints are faced, so that choices must be made.
There are constraints in relation to natural and environmental resources and
hence choices should be made.
 3 Themes of the course
1. Efficiency (missed opportunities)
o Technical (physical) efficiency
If resource use is wasteful in some way, then opportunities are being
squandered; eliminating that waste (or inefficiency) can bring net
benefits to some group of people
o Allocative efficiency
 The ability of the farmer to consider cost aspects when combining
inputs
o Economic efficiency
 It measures overall efficiency, including both technical and
allocative efficiencies.
2. Optimality (socially)
3 Themes of the
o a resource-use course
choice is socially optimal if it maximises a society’s
objective given any relevant constraints that may be operating
o Premises (assumption)
a society with some overall objective so that we can measure the
extent to which some resource-use decision is desirable from that
society’s point of view
NB: efficiency and optimality are related
3 Themes
efficiency ofis athe course
necessary condition for optimality, but efficiency is not a
sufficient condition for optimality (even if a resource allocation is
efficient, it may not be socially optimal)
a resource allocation cannot be optimal unless it is efficient (if society
squanders opportunities, then it cannot be maximising its objective)

3.Sustainability
Taking care of posterity
meeting the needs of the present without compromising the ability of
future generations to meet their own needs.
 Natural Resources Vs. Environmental Resource/Economics
 Natural resources are taken to be those components of land units that are of
direct economic use for human population groups living in the area.
To a large degree, these resources can be quantified in economic terms
and 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 include scenic/aesthetic, 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; and others
Environmental resources are to a large degree "non-tangible" in strictly
economic terms and they are provided by nature that are indivisible.
Natural resources serve as inputs to the economic system but the system
affect environmental resources (e.g. pollution).
Natural Resources Economics: the study of how society allocates scarce
natural resources such as stocks of fish, stands of trees, fresh water, oil, and
other naturally occurring resources.
It is about problems of managing common-pool/open access natural
resources, determining optimal rates of extraction, & understanding
resource markets.
Common-pool natural resources: difficult to exclude access, but once
extracted is no longer available to others (groundwater, rivers, fisheries,
public forests)
Environmental Economics: It is concerned with the way wastes are disposed of
and the resulting quality of air, water, and soil serving as waste receptors.
In addition, environmental economics is concerned with the conservation of
natural environments and biodiversity.
It is economic basis for pollution problems & policy alternatives.
Environmental and natural resource economics is the application of the
principles of economics to the study of how environmental and natural resources
are developed and managed.
Three ethical perspectives/ philosophical views
Anthropocentrism = only humans have intrinsic value
Biocentrism = some non-human life has intrinsic value
Ecocentrism = whole ecological systems have value
 A holistic perspective that preserves connections
 The Emergence of Resource and Environmental Economics

• Classical Economics (1700-1800 century): The Contributions of Adam Smith,

Thomas Malthus, David Ricardo, John Stuart Mill and Karl Marx to the
Development of Natural Resource Economics
Adam Smith
• Scottish economist who wrote “The Wealth of Nations (1776)” - Markets allocate
resources efficiently via the "invisible hand" (self-interest driving societal
benefit).
held that the best government economic policy was to leave the market alone
to follow a laissez faire or “let it be” policy of little or no gov’t intervention
Implication
• Assumption of Abundance: Viewed air, water, and forests as "free gifts of
nature" with no need for regulation.
• No Externalities: Ignored pollution or overexploitation of commons (e.g.,
fisheries) as market failures.
• Anthropocentrism: Valued nature only for its utility to humans.
• Short-Term Focus: Prioritized wealth accumulation over long-term
sustainability.
• His laissez-faire ideology clashed with later environmental regulations (e.g.,
emissions controls).
Thomas Malthus (1766–1834):
is best known for his theories on population growth and resource scarcity.
His work, particularly ”An Essay on the Principle of Population (1798)”, offers
critical insights into how natural resources and environmental constraints shape
economic outcomes.
He argued that human populations grow geometrically (1, 2, 4, 8…), while
agricultural production increases arithmetically (1, 2, 3, 4…). This mismatch leads
to inevitable scarcity.
It mean population grow faster than food supply; he said that “mankind was
condemned to overpopulation and “checks” on the population by war, famine,
disease and mother nature (earthquakes, floods, drought)”
Malthus viewed arable land as finite and subject to diminishing returns. As
population grows, poorer-quality land is cultivated, reducing per capita food
output.
 He warned that overuse of land (e.g., overcultivation) would degrade soil
fertility, exacerbating scarcity and triggering crises.
David Ricardo (1772–1823)

•How his theories apply to natural resource and environmental economics?

Key Economic Theories of Ricardo

i.Theory of Rent: How land productivity differences determine land value
ii.Comparative Advantage: Specialization in production based on opportunity
costs
iii.Diminishing Returns: Increasing production leads to higher costs and
resource depletion

His theories on land rent and resource scarcity remain highly relevant in
environmental economics today.
 Rent arises due to variations in land fertility and location.
 The most fertile and well-located lands yield the highest returns.
 As population and demand grow, less fertile land must be cultivated,
increasing the price of superior lands.
 Land scarcity and increased exploitation can lead to overuse, pollution
and habitat destruction (degradation of natural resources), returns
decrease (Diminishing Returns)
 Ricardo’s comparative advantage explains global trade in natural
resources
 Environmental concerns: Overexploitation of resources in developing
countries
 Deforestation, mining, and climate impacts from trade
John Stuart Mill (1806–1873):
His views on resource distribution, environmental stewardship, and
sustainable growth remain relevant today.
He belief that perpetual economic growth is neither possible nor desirable
Advocated for a steady-state economy (A stage where economic growth slows, and
focus shifts to sustainability and well-being) with stable population & resource use
Recognized that natural resources are finite and advocated for conservation
and responsible resource use
Anticipated problems of pollution, deforestation, and industrial waste
Emphasized the importance of public goods and environmental protection
Advocated for taxation on resource use to prevent over-exploitation and
supported regulation of pollution and land use (Foundation for green taxes,
environmental regulations, and carbon pricing)
Neoclassical economics

Emerged in the late 19th and early 20th centuries (Alfred Marshall, Léon
Walras, William Stanley Jevons)
Neoclassical economics provides valuable tools for addressing
environmental challenges through market-based solutions.
However, market failures require government intervention to ensure
sustainable resource management.
Integrating economic policies with environmental considerations is
essential for long-term sustainability.
Core Principles of Neoclassical Economics
Utility Maximization: Consumers make rational choices to maximize
satisfaction.
Profit Maximization: Firms aim to maximize profits by efficiently using
resources.
Marginal Analysis: Decisions are made based on marginal costs and benefits.
Market Efficiency: Free markets lead to optimal resource allocation, assuming
no market failures.
Neoclassical Views on Natural Resources
Resource Scarcity & Pricing: Market forces determine the price of natural
resources based on supply and demand.
Substitution & Technological Progress: As resources become scarce,
alternatives emerge (e.g., renewable energy replacing fossil fuels).
Efficient Resource Use: Competitive markets encourage sustainable extraction
and use of resources.
Early 20th Century: Conservation and Resource Use
 Economists such as Harold Hotelling (1931) introduced theories on the optimal use of
exhaustible resources, leading to Hotelling’s Rule, which describes how resource
prices should rise over time as scarcity increases.
 Growing industrialization raised concerns about pollution and externalities (Arthur
Pigou, 1920).
 Pigovian taxes were proposed to correct market failures caused by environmental
damage.
Market Failures in Environmental Economics
 Externalities: Costs or benefits not reflected in market prices (e.g., pollution, carbon
emissions).
 Public Goods: Environmental resources like clean air and water are often underprovided
by markets.
 Tragedy of the Commons: Overuse of shared resources due to individual incentives.
 Asymmetric Information: Lack of awareness about environmental damage leads to poor
decision-making.
Post-World War II: Economic Growth and Environmental
Awareness
The post-war economic boom led to increased exploitation of natural
resources, but also raised concerns about pollution and sustainability.
The 1960s and 1970s saw the rise of environmental movements,
influenced by works like Silent Spring (Rachel Carson, 1962) & The
Limits to Growth (Meadows et al., 1972).
The Tragedy of the Commons (Garrett Hardin, 1968) illustrated the
problem of overexploitation of shared resources, influencing policies
on fisheries, deforestation, and air pollution.
Institutionalization of Environmental Economics (1970s–1990s)
Governments and international organizations began implementing
environmental regulations, including the U.S. Clean Air Act (1970) and
the establishment of the Environmental Protection Agency (EPA).
The concept of sustainable development gained prominence with the
Brundtland Report (1987), defining it as development that meets present
needs without compromising future generations.
Market-based instruments such as carbon taxes, pollution permits (cap-
and-trade), and payments for ecosystem services (PES) became widely
studied and applied.
Modern Developments and Global Challenges (2000s–Present)
• Climate change, biodiversity loss, and ecosystem services became central
issues in NREE.
• Advances in ecological economics emphasized integrating ecological
constraints into economic models.
• The rise of circular economy and green growth concepts focuses on
reducing waste and promoting sustainable production.
• International agreements, such as the Paris Agreement (2015), highlight the
role of economics in tackling climate change.
1.3. Fundamental Issues in the Economic Approach to Resource and
Environmental Issues
1. Market Failures and Externalities
• Many environmental and resource issues stem from market failures, where free
markets fail to allocate resources efficiently.
• Externalities occur when the costs or benefits of resource use affect third parties
who are not directly involved in the economic transaction (e.g., pollution).
2. Public Goods and Common-Pool Resources
• Environmental resources often exhibit characteristics of public goods (e.g.,
clean air, biodiversity) and common-pool resources (e.g., fisheries, forests).
• These resources are subject to overuse and depletion due to lack of well-defined
property rights (the “tragedy of the commons”).
3. Property Rights and Resource Management
• Well-defined, enforceable, and transferable property rights are crucial for
efficient resource use.
• Open-access resources lead to overexploitation, whereas private or
communal ownership can help manage resources sustainably.
4. Intertemporal Resource Allocation and Discounting
• Resource economics must balance present and future consumption
through discounting.
• High discount rates may lead to excessive depletion, while lower rates
favor sustainability.
5. Valuation of Environmental Goods and Services
• Many environmental goods (e.g., clean air, ecosystem services) lack
market prices, making their valuation difficult.
• Methods such as contingent valuation, hedonic pricing, and cost-benefit
analysis help estimate these values.
6. Policy Instruments and Regulation
• Governments intervene through policies such as taxes, subsidies, quotas,
tradable permits, and regulations to correct market failures.
• The effectiveness of policies depends on enforcement, compliance, and
political feasibility.
7. Uncertainty and Irreversibility
• Many environmental decisions involve uncertainty (e.g., climate
change impacts, biodiversity loss).
• Irreversible changes (e.g., species extinction) necessitate a
precautionary approach.
8. Sustainability and Equity Considerations
• Sustainable development aims to balance economic growth,
environmental protection, and social equity.
• Intergenerational equity requires managing resources to ensure future
generations have access to essential environmental goods.
 CHAPTER TWO
CONCEPT OF SUSTAINABILITY
2.1. The Origins of Sustainability Problem
•The relationship between social progress, environmental deterioration, and
economic growth is where the sustainability issue first emerged.
•Throughout history, communities have depended on natural resources to boost
economic expansion and raise living standards.
•But this dependence has frequently resulted in resource depletion, social
inequality, and environmental devastation
•The sustainability problem arises from the tension between economic growth,
environmental constraints, and social equity.
 Key Historical Factors Contributing to the Sustainability Problem
i. Industrial Revolution (18th–19th Century)
•Rapid industrialization led to increased energy consumption (primarily coal)
and large-scale resource extraction.
•Pollution and deforestation accelerated, disrupting ecosystems and human
health.
•Economic growth was prioritized over environmental considerations.
ii. Population Growth and Resource Exploitation
•The global population has grown exponentially, increasing demand for food,
water, and energy.
•Overfishing, deforestation, and fossil fuel consumption have pushed
ecosystems beyond their regenerative capacities.
 Cont`d

iii. Market Failures and Externalities

•Environmental degradation is often an externality—costs like pollution and
climate change are not fully accounted for in market prices.
•Tragedy of the Commons: Shared resources (e.g., fisheries, forests) are
overused and depleted due to lack of effective regulation.
iv. Technological Advancements and Consumption Patterns
•Innovations in agriculture and industry increased resource efficiency but also
enabled higher consumption.
•Consumerism, particularly in high-income countries, has driven
unsustainable production and waste.
 Cont`d
v. Climate Change and Global Environmental Issues
•Greenhouse gas emissions from industrial activities have contributed to climate
change, leading to extreme weather events, sea level rise, and biodiversity loss.
•Environmental justice concerns highlight how poorer communities are
disproportionately affected by environmental harm.
vi. Globalization and Economic Inequality
•Economic globalization has led to resource exploitation in developing countries
for the benefit of wealthier nations.
•Inequities in wealth and power hinder sustainable development and environmental
protection.
Addressing it requires systemic changes in policies, technologies, and societal
values to balance development with ecological and social well-being.
 Cont`d
2.2. Economic-Environment Interdependence
•Economic activity takes place within, and is part of, the system which is the
earth and its atmosphere.
•This system we call ‘the natural environment’, or more briefly ‘the
environment’.
•This system itself has an environment, which is the rest of the universe.
•The economy is located within the environment.
 Cont`d
• The environment provides four functions to the economy
1. source of resource inputs
2. source of amenity services
3. receptacle for wastes
4. provides life support services
• These environmental functions interact with one another in various ways,
and may be mutually exclusive
• There exist possibilities to substitute reproducible capital for ‘natural
capital’
 Classification of Natural Resources

Natural resources

Stock resources Flow resources

Solar radiation, wave and wind power

Renewable Nonrenewable
resources resources
Economic activity causes environmental
impacts!
Energy Mineral
resources resources
 The drivers of environmental impact
• The environmental impact of economic activity can be looked at in terms
of:
extractions from the environment
insertions into the environment
• In either case, the immediate determinants of the total level of impact are:
the size of the human population
the per capita impact (affluence and technology)
• The per capita impact depends on:
how much each individual consumes
the technology of production.
 The IPAT identity
• A simple but useful way to start thinking about what drives the sizes of the
economy’s impacts on the environment.
• It can be formalized as the IPAT identity:
I=PxAxT
I: impact, measured as mass or volume
P: population size
A: per capita affluence, in currency units
T: technology, amount of the resource used or waste generated per unit production
Measure impact in terms of mass
GDP Resource Use
• Use GDP for national income. I P  
P GDP
• Then T is resource or waste per unit GDP.
• Then for the resource extraction case, we have: A T
 An illustration of IPAT
• The IPAT identity decomposes total impact into three multiplicative
components – population, affluence and technology.
• Consider global carbon dioxide emissions.
• The first row of Table 2.4 shows the current (2005) situation.
• A is 2005 world GDP per capita in 2005 PPP US$
• I is 2004 global carbon dioxide emissions taken from the indicated source
• The figure for T is calculated by dividing I by P times A to give tonnes of
carbon dioxide per $ of GDP.
• Many climate experts believe the current level of carbon dioxide emissions
to be dangerously high.
 P A T I
(billions) (PPP US $) (tonnes per $) (billions of
tonnes)

Current 6.5148 9543 0.0004662 28.9827

P x 1.5 9.7722 9543 0.0004662 ???

P x 1.5 and 9.7722 19086 0.0004662 ???

Ax2

P x 1.5 and 9.7722 19086 ??? 28.9827

A x 2 with
I at current

Source: UNDP (2007)

 2.3. Sustainable Development (SD)
• Sustainable development is fulfilling the needs of the present without
compromising the ability of the future generations to meet their own needs
Operational definition of SD
sustainable development is a process of change in which
the exploitation of resources
the direction of investments,
the orientation of technological development and
institutional change are all in harmony and enhace both current and
future potential to meet human needs and aspirations’
 Cont`d

• ‘how to be sustainable?’ – 4 things have to be addressed

simultaneously:
how we use resources?
what do we spend money on?
What technologies to focus on?
how to change our decision-making processes?
• the need for change in decision making processes
decision making must incorporate all aspects of sustainability:
development, environment and societal good
 Cont`d
Sustainability principles
•Our understanding of SD depends on our value system, societal and
normative choices. Hence, there is no objective view of what is sustainable
•Equality is everything: inter- and intra-generational, geographical,
procedural, interspecies
•Sustainability is a holistic problem. It cannot be addressed without a whole-
system approach
•Sustainability is not an end-state – it is a process of evolution towards the
more sustainable manner of living
 Linkages of development, environment and equality:
• degradation of environment is caused by few technologically developed countries,
but affects all
• it is unthinkable to limit the development of poorer countries in order to limit the
impact on environment from development; development and environmental
degradation must be de-coupled
• poverty leads to environmental degradation
• our inability to meet the needs of many people are not due to lack of resources,
but due to state of technology and ineffective social organizations to use
sustainably
 Cont`d
Linkages between sustainable development and the environment
a development path is sustainable ‘if and only if the stock of overall
capital assets remains constant or rises over time’
the preservation or loss of valuable environmental resources should be
factored into estimates of economic growth and well-being
NNP* =GNP –Dm –Dn – R –A
NNP*: sustainable net national product
Dm: depreciation of manufactured capital assets
Dn: depreciation of environmental capital: monetary value of environmental decay over
a year
R: expenditure required to restore environmental capital (forests, fisheries etc.)
A: expenditure required to prevent destruction of environmental capital
 2.4. Sustainability Criteria ‘s
2.4.1. Weak Sustainability
• Definition: Assumes natural capital (e.g., forests, water, biodiversity) can be
replaced by human-made capital (e.g., infrastructure, technology).
• Key Idea: As long as overall capital (natural + human-made) remains
constant, sustainability is maintained.
• Example: If a forest is cut down but a new factory is built that benefits
society, weak sustainability suggests this trade-off is acceptable.
• Criticism: Some resources (like clean air or biodiversity) may not be
replaceable.
 Cont`d

Key Principles:
•Substitutability: Technology can replace lost natural resources.
•Economic Growth: Prioritizes GDP growth with environmental mitigation.
•Market Solutions: Carbon trading, offset schemes.

Theorists: Robert Solow, John Hartwick.

Key Critiques:
• Overestimates substitutability (e.g., irreplaceable ecosystems).
• Ignores planetary boundaries (e.g., climate tipping points).
• Favors wealthy nations (e.g., carbon offsets shifting burden).
 Cont`d

2.4.2. Strong Sustainability

• Definition: Natural capital is not fully substitutable; it must be preserved.
• Key Idea: There are ecological limits that human-made capital cannot
replace.
• Example: Preserving a rainforest rather than compensating for its loss with
technological solutions.
• Importance: Protects ecosystems, biodiversity, and ensures future
generations have access to natural resources.
 Cont`d

Key Principles:
• Non-Substitutability: Critical natural capital (e.g., oceans, ozone layer)
must be preserved.
• Precautionary Principle: Avoid irreversible harm.
• Ecological Limits: Prioritize planetary boundaries.
•Theorists: Herman Daly, Ecological Economics School.
Key Critiques:
• Seen as "anti-growth" (challenges capitalist economies).
• Difficult to implement globally (e.g., conflicting national interests).
• Requires radical systemic change (e.g., degrowth).
 Weak vs. Strong: A Comparison
Aspect Weak Sustainability Strong Sustainability
No (natural capital is
Yes (natural ↔ human-
Substitutability critical) - prioritizes
made) - allows trade-offs
conservation
Supports GDP/economic Limits growth to ecological
Growth Focus
growth caps
Case Study Debate Strict regulations,
• Policy
Scenario:Tools
Should a country Carbon trading,
replace a forest techfarms?
with solar fixes
conservation
• Weak Perspective: Yes, if emissions are reduced.
• Strong Perspective: No—forests are irreplaceable.
 Sustainability and Efficiency in Environmental Economics
Sustainability and efficiency are fundamental concepts in
natural resource and environmental economics, shaping how
we use and manage Earth's resources.
• While they can sometimes complement each other, they may
also create conflicts, depending on how they are applied.
Three Pillars of Sustainability
1.Environmental Sustainability – Ensuring that ecosystems and
natural resources remain intact and functional over time.
Example: Protecting forests to maintain biodiversity and prevent soil
erosion.
 Cont`d

2. Economic Sustainability – Ensuring that economic activities can

continue without exhausting natural capital.
Example: Investing in renewable energy instead of depleting fossil fuels.
3. Social Sustainability – Ensuring that development benefits society
fairly, without marginalizing communities or harming health.
Example: Preventing pollution in low-income areas to protect public
health.
Efficiency in economic terms refers to maximizing output while
minimizing waste. In environmental economics, efficiency means using
resources in a way that produces the greatest benefit at the lowest
environmental cost.
 Types of Efficiency
1. Allocative Efficiency – Resources are distributed optimally, reflecting
consumer demand and producer supply.
Example: If clean energy is cheaper than fossil fuels, society should allocate
more investment toward renewables.
2. Productive Efficiency – Producing goods using the least amount of
resources and energy.
Example: Using drip irrigation in agriculture to reduce water waste.
3. Dynamic Efficiency – Long-term innovation that improves efficiency over
time.
Example: The shift from coal to solar power as solar technology improves.
 Cont`d
Market-Based Efficiency Approaches
• Pigouvian Taxes: Charging polluters a tax equal to the environmental
damage they cause (e.g., carbon tax).
• Cap-and-Trade: Setting a limit (cap) on pollution and allowing businesses to
trade emissions permits.
• Subsidies for Green Technologies: Encouraging efficiency by making clean
energy and sustainable practices more affordable.
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