Block 2

MSD-014
ECOLOGICAL ECONOMICS
Indira Gandhi
National Open University
School of Interdisciplinary and
Trans-disciplinary Studies
Block
2
RESOURCE AND ECONOMY
UNIT 1
Economic Theories of Renewable and Non-Renewable
Resources 5
UNIT 2
Resource Exploitation and Environmental Degradation 18
UNIT 3
Market, Trade and Environment 34
UNIT 4
Economic Activity : Impacts 49
PROGRAMME DESIGN COMMITTEE
ADVISORS Prof. M.S. Swaminathan Dr. (Mrs.) Latha Pillai
Prof. V. N. Rajasekharan Pillai Honorary Chair, Chair for Former Pro-Vice Chancellor and
Former Vice-Chancellor, Sustainable Development Executive Director, CSD,
IGNOU, New Delhi IGNOU, New Delhi IGNOU, New Delhi
EXPERT COMMITTEE
Prof. P.C. Kesavan Dr. A.K. Shiva Kumar Prof. M.K. Salooja
Emeritus Professor Advisor, UNICEF, New Delhi CSD & SOA, IGNOU, New
CSD, IGNOU, New Delhi Delhi
Dr. Swarna S. Vepa
Prof. P.S. Ramakrishnan,
Madras School of Economics, Chennai Prof. K.S. Rao
JNU, New Delhi
Dept. of Botany,
Dr. P. A. Azeez Dr. Nehal A. Farooque University of Delhi
Sálim Ali Center for Ornithology and Natu- SOEDS, IGNOU
ral History (SACON), Coimbatore Dr. Subhakanta Mohapatra
Dr. Bibhu Prasad Nayak, SOS, IGNOU
Dr. Tanushree Bhattacharaya The Energy and Research Institute (TERI),
Institute of Science and Technology for New Delhi Dr. Anjan Prusty
Advance Studies and Research (ISTAR), Sálim Ali Center for Ornithol-
Gujarat Dr. Oinam Hemlata ogy and Natural History
Dr. Jagdamba Prasad School of Human Ecology (SACON), Coimbatore
ARD, Regional Service Division Ambedkar University, New Delhi
IGNOU Dr. Narendra Kumar Sahoo,
Dr. Y. S. Chandra Khuman Civil Engineering Department,
Dr. Naresh Chandra Sahu SOITS, IGNOU, New Delhi Maharishi Markandeshwar
Department of Humanities, Social University, Ambala
Sciences, and Management
Indian Institute of Technology
Bhubaneswar (IITBBS), Odisha
PROGRAMME COORDINATOR
Dr. Y. S. Chandra Khuman
SOITS, IGNOU, New Delhii
COURSE EDITOR COURSE COORDINATOR BLOCK COORDINATOR

Prof. D.K. Marothia Dr. Y. S. Chandra Khuman Dr. Y. S. Chandra Khuman
Founder professor and Head, SOITS, IGNOU, New Delhi SOITS, IGNOU, New Delhi
Department of Agricultural and
Natural Resource Economics
Indira Gandhi Agricultural
University, Raipur, Chhatisgarh
FORMAT EDITOR
Dr. V. Venkat Ramanan
SOITS, IGNOU, New Delhi
UNITWRITERS
Unit 1 Economic Theories of Renewable & Non-Renewable Resources Dr. Naresh Chandra Sahu
Unit 2 Resource Exploitation and Environmental Degradation Dr. Swarna S. Vepa
Unit 3 Market, Trade and Environment Dr. Swarna S. Vepa
Unit 4 Economic Activity : Impacts Dr. Swarna S. Vepa
PRINT PRODUCTION
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© Indira Gandhi National Open University, 2017
ISBN: 978-93-86607-11-9
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INTRODUCTION TO BLOCK-2
The major objective of Block-2 is to explain the economic theories of renewable
and non-renewable resources; emphasize rampant resource exploitation and causes
of environmental degradation; illustrate the linkage existing between trade, market
and environment; and state the impacts of economic activity.
The Block-2 on “Resource and Economy” comprises of four units. The Unit-1 is on
“Economic Theories of Renewable and Non-Renewable Resources”. Resources
are essential for economic development. This unit familiarizes you with the basic
concept of Renewable and Non-Renewable Resources, Bio-Economic Model,
Limitations of Steady-State Bio-Economic Model, Optimal Allocation of Non-
Renewable Resources and Limits to Economic Growth.
The Unit-2 deals with “Resource Exploitation andEnvironmental Degradation”. This
unit familiarizes you with nature of resources and meaning of natural and man-made
capital.
Unit-3 is on “Market, Trade and Environment”. This unit introduces you to the basic
principles of neoclassical economics with respect to market equilibrium and market
behavior.You also will be learning in this unit, the impacts of International Trade and
Globalization on Sustainabilityof Resource Extraction.
Unit-4 is on “EconomicActivity– Impacts”.Through this unit, you will be introduced
to Co-evolutionary Economics, Concept of Carrying Capacity and Overshoot,
Biodiversity Loss and Impacts of Climate Change.
UNIT 1 ECONOMIC THEORIES OF
RENEWABLE AND NON-
RENEWABLE RESOURCES
Structure
1.0 Introduction
1.1 Objectives
1.2 Economics Theories of Renewable Resources
1.3 Economics of Fishery : Bio-economic Model
1.4 Regulation of Fishery
1.5 Limitations of Steady-State Bio-economic Model
1.6 Economic Theories of Non-renewable Resources
1.7 Optimal Allocation of Non-renewable Resources
1.8 Non-renewable Resources and Limits to Economic Growth
1.9 Let Us Sum Up
1.10 Key Words
1.11 References and Suggested Further Readings
1.12 Key to Check Your Progress
1.0 INTRODUCTION
The different kinds of resources and their characteristics are discussed in detail
in resource taxonomy in previous courses. Broadly, natural resources can be
grouped into following four categories (Kerr and Swarup, 1997):
a) Basic natural resources such as land, water and air
b) Natural resource commodities such as timber and fish
c) Environmental amenities such as clean air and scenic views
d) Environmental processes such as pollution, soil erosion, groundwater recharge,
and species regeneration
With reference to time, the resources can be classified into two major categories
i.e., renewable and non-renewable resources. The renewable or non-renewable
resources could either be stock or flow (Table 1.1). Renewable resources are
those resources that are capable of regenerating themselves, either naturally or by
human activity within a relatively short period of time. Examples of renewable
natural resources include forests, wildlife, groundwater, fish, etc. In fact, the
regeneration capability depends on the resource systems. The pace of natural
regeneration is higher with resources undisturbed or least disturbed by human
beings and the highly degraded resource systems is less likely to regenerate
without some of other form of assistance. Renewable resources also include flow
5
Resource and Economy resources like wind, sunlight, water streams and so on. Non-renewable resources
are defined as those which are not replaceable, or replace so slowly by natural
or artificial processes that for all practical purposes, once used they would not be
available again within any reasonable time frame. Obvious examples are oil and
mineral deposits.
Table 1.1: Classification of Resources with examples

Stock Flow
Non-renewable Coal, oil, iron, copper, Wind, flowing river water
other metals, old-growth
timber, soils
Renewable Water stored in tanks, Young-growth timber,
solar energy stored in annual crop
cells
Source: Kerr and Swarup, 1997
Economics is the science of allocation of scarce resources and concerned with

allocation strategies with optimal outcome. Economists define these renewable
and non-renewable resources based on their supply provision characteristics.
Non-renewable resources are characterized with a fixed stock and are limited in
supply compared to demand for them. Renewable resources though have a fixed
stock at any point of time is expected to be replaced by new stock with use of
the specific resource by natural processes. Economists often categorize a specific
natural resource both renewable and non-renewable based on its flow. For example
old trees with life span of as much as 500 years while renewable by the common
definition, may be classified as non-renewable by economists scholars due to their
slow growth to maturity. They may be ecologically unique and not reproducible.
In a similar way, while coal would be considered non-renewable by some scholars
most of the resource economics scholars would consider it renewable due to the
huge stock. It is estimated that there is enough coal to last more than thousand
years. From economics point of view, there is no immediate coal scarcity in the
near future due to its huge stock and hence for economists it seems renewable.
In fact, there is no scarcity rent associated with its extraction.
The basic economic theories of renewable resources would be discussed in detail

in the following sections. The major economic issues pertaining to the study of
non-renewable resources have involved forecasting the future price and production
paths as well as the timeline for the possible resource exhaustion.
1.1 OBJECTIVES
After reading this unit, you will be able to:
l explain the basic concept of renewable and non-renewable resources;
l describe the economic theories of renewable and non-renewable resources;

and
l analyze the relationship between non-renewable resources and limits to

6 economic growth.
Economic Theories of
1.2 ECONOMIC THEORIES OF RENEWABLE Renewable and Non-
Renewable Resources
RESOURCES
As discussed in previous section, the basic economic theories of renewable
resources based on the notion that these resources are capable of regenerating
themselves within a relatively short period of time provided natural environment
in which they are residing and growing is not disturbed. It is observed that
biological resources such as fish and wild life populations are renewable resources
because as living creatures, these resources has a birth, growth and death cycle
through natural processes of systematic reproduction, ageing and so on. These
processes involve very complex interactions, interdependence, interrelationships
between living and non living matters including human being. Now the question is
how to achieve sustainable management of renewable resources which are under
tremendous pressure from various sources including human intervention. The
management of biological resources indicates that the use of these resources for
human ends should be on a sustainable basis. First of all, sustainable management
of these resources require the information on the nature of the reproduction and
growth of the biological resources in question. It is very difficult to obtain this kind
of information due to fact that there are so many unknowns in the biology and
ecology of the resource populations under study. However, some models have
been developed by the scholars to look into the study of assessing and projecting
the growth of the ecological and biological resources for harvesting strategy. In
most of the models, certain variables are used for critically assessing allowable
size of biological resources for harvest. These variables include the initial population
size, the age and sex mix, the spatial and temporal distribution of the resource and
the natural mortality rate.
Models with a specification of this type assume a vital place in the empirical work
and management practices of fishery and wild life in general.
Now let’s build a model by using some features of particular biomass.
Let’s consider Bt is the population or the biomass of a biological resource
measured in some standard unit at a point in time t. t is the time interval, generally
a short period of time measured in months or years. B( t + t) is the biomass after

time interval t has elapsed. Bt is a stock concept as it represents the population

or biomass at a point of time. This stock is however composed of population of
a biological species comprising of different sex, age, size and shape, and weight.
B( t + t) is a flow concept since it indicates a change in the stock of the biomass

over specified interval of time t. The change in the stock could result from a
combination of biological and ecological and socioeconomic factors such as
natural reproduction through birth, growth of the biomass of the existing population,
natural death, and prey-predator relationships, where the predators include
human being. By using the common features of biological resources, a following
relationship can be made.
= Bt + g (Bt , )

B(t+ 
t) t (1)
Where, g (Bt) is a function representing the natural growth of the population
biomass per unit of time. It is to be noted that this natural growth function is
assumed to depend on the size of the initial population size, Bt. The variable 
represents other related factors like age distribution, sex composition, other unique
biological traits of the resource, and other environmental factors that affects the
rates of growth of population biomass. The expression g (Bt , ) t on the right

7
Resource and Economy side of the equation (1) indicates the total increase in biomass during the time
interval [t, (t+ t)].
If we assume to be exogenously determined variable and capable of being treated
as a constant parameter, then the increment in the biomass of the initial population,

Bt during the time interval [t, (t + t)], can be expressed as:
Bt = g (Bt , )
 
[B (t +

t) - Bt] = t (2)

Or, if we divide both sides of the equation (2) by t, the growth of the stock
per unit time would be given by
 
Bt / t = g (Bt) (3)
Above equation states that under normal condition the growth of the biological
resource per unit time depends primarily on the size of the initial population. It is
to be considered here that this growth in biomass is net of natural mortality since
this factor is already accounted by the variable. Thus the growth function g(Bt)
represents a net addition to the natural size of the underlying population per unit
time. In fact, it states the natural growth function of the biological resource under
study. It is fact that the stock B, grows over time suggests that the size of stock
is a function of time. If this dynamic feature of biological resources is to be
captured, then the growth function needs to be specified as g [B(t) ] otherwise
equation (3) is static model which denotes the growth of stock per unit time .
It doesn’t account the dynamic change in the stock over time.
Example: The above model represented by equation (3) can be understood by
citing a simple hypothetical example. Suppose country ‘X’ claims that it has a tiger
population of 3 million. Based on the past experience, the Ministry of Environment
and Forest for the above mentioned country claims that, on average, the population
growth (net of natural predators) of the tiger population has been about 100,000
biannually. Given these estimates of the initial population size and the rate of
biannual recruitment, what is annual growth of the tiger population for country
‘X’?
From the above information B0, the estimate of the initial (i.e. when t =0) tiger
population is 3,000,000; when t is 2 years, the tiger population after the initial
period is B0+2 = B2 = 3,100,000. This figure is estimated after accounting the
natural mortality. By using the given information, annual growth of the tiger
population can be computed using the equation (3).
That is:
  
g (Bt) = Bt / t=[B (0+2) - Bt ] / t = 100,000/2= 50,000 tiger..
What is the use of this calculation? By using the annual growth figure, we can
chalk out the future course of actions for conserving the endangered species i.e.
tiger.
1.3 ECONOMICS OF FISHERY :

BIO-ECONOMIC MODEL
The natural growth rate of a renewable resource says, for each population size,
the maximum amount that can be harvested on a sustainable basis without affecting
the underlying population size. As such, sustainable harvest or catch will be attained,
8 if during any given period of time, humans remove an amount equal to the natural
annual increase. However, there are infinite numbers of sustainable harvests along Economic Theories of
Renewable & Non-
the natural growth curve, each corresponding to a different population size. So, Renewable Resources
which one of this infinite number of choices is most desirable, can be addressed
either by a purely bio-physical viewpoint or the bio-economic perspective.
From the bio-physical viewpoint, the most desirable choice of population would
be the one that maximizes the biomass that can be harvested on a sustainable
basis or as it is called Maximum Sustainable Yield (MSY) i.e. maintaining the
population size consistent with the maximum level of sustainable harvest. Though
it takes full consideration of the relevant biophysical factors affecting the natural
growth function of the resource in question (here fishery), no considerations are
made about either the cost of harvesting the amount of fish biomass or the total
social benefit (as measured by the market value) to be derived from this level of
harvest. If suppose the society can obtain a net benefit (total benefit-total cost)
that is greater than at the maximum sustainable yield harvest level with harvesting
less than the MSY, then the MSY in this case may not represent an economic
optimum (where net benefit is the maximum). In fact, there is only one situation
in which a maximum sustainable resource management will certainly be expected
to yield a result consistent with an economic optimum. This occurs only if, the cost
of labour, capital and other materials used for harvest is assumed to be zero which
is rather an unrealistic situation.
Hence, an alternative approach, the bio-economic perspective, suggests that the
choice of the most desirable sustainable harvest should depend upon the interaction
of three key variables: the nature of the underlying natural growth function; the
specific size of the fish population; and the amount of economic resources used
for harvesting. In fishery economics, the phrase fishing effort is used to describe
a composite economic factor (such as labour, capital, energy and other raw
material) used in fish harvesting activities. It is an index of factor inputs with
significant measurement difficulties.
The production function of a fishery that shows the relationships among the levels
of catch, effort and population size can be defined as follows:
H = f (B, E) (4)
Where H is the fish catch or harvest due to human exploitation, E is the level of
fishing effort, and B is the stock or fish biomass or simply the fish population. In
general, this production function speaks that for a given population size, the higher
the level of effort, the larger will be the harvest or catch; and given the level of
effort, the larger the population size, the larger will be the catch.
However, the above interrelationships among the levels of harvest, effort and
population size do not address the issue of whether the harvest under any given
condition is sustainable or not. For this, we need to take into consideration, the
natural growth rate of the renewable resource in question that is fish. It is important
to note here that there is a one to one correspondence between effort and
equilibrium population size (where natural growth equals the biomass that can be
harvested on a sustainable basis). That is for a given level of effort, a unique
equilibrium population size will result, yielding a sustainable harvest. This occurs
because harvest is replaced by a natural growth rate. This is referred to as
steady-state bio-economic equilibrium. Algebraically, this equilibrium condition is
attained when the following condition is met:
9
 
Resource and Economy Bt/ t = g (Bt) – Ht = 0 (5)
where H t is the harvest per unit time. According to the above equation, at any
point in time, harvest is offset by natural growth, thus allowing the underlying
population size to remain constant.
In fishery economics, sustainable yield is nothing more than the natural growth
expressed in terms of effort. Each point along the sustainable yield curve assumes
an equilibrium population size that corresponds to a given level of effort. The level
of effort and the equilibrium population size are inversely related. This suggests
that excessive harvesting (or application of effort) of a renewable resource could
lead to its irrevocable destruction or extinction. The sustainable yield curve has
the most direct application to resource management in the sense that effort can
be controlled by human beings. In fact, this curve is viewed as the long-run
production function of the biological resource.
Fig. 1: Production Function of Fishery: The Sustainable Yield Curve
Source: Hussen (2000).
1.4 REGULATION OF FISHERY

From a purely economic point of view, the desired policy objective to regulate
fishery would be to restrict access to the fishery in such a way that misallocation
of societal resources are avoided. Among the several traditional policy instruments,
the most commonly used methods of fishery regulations fall into the following
categories: fines, such as taxes on harvest or on effort; quotas-limits on the total
quantity of harvest within a given season; technological standards, such as
restrictions on the kinds of fishing nets, boats and fishing gear to be used; and
assignment of private property rights-most recently, a variation of this approach
called individual transferable quotas (ITQs) has been gaining increasing popularity.
ITQs have the benefit of allowing marginal shareholders to get out of the fishery
with some money. The down side is that such systems allow a small number of
individuals or companies to buy control over the fishery. When New Zealand was
in the process of instituting an ITQ system, highly capitalized fishing companies
10 expanded their operations beyond the level of catch they could sell profitably so
that they would control a higher percentage of the fishery at the time of the initial Economic Theories of
Renewable & Non-
allocation of quotas. If regulators do not act to prevent such “capital stuffing”, Renewable Resources
ITQs can reward the very fishers who overcapitalized the fishery in the first place,
while squeezing out smaller operations.
The real problem is generally not in deciding which particular public policy
instrument(s) to use but rather the effective implementation of the policy under
consideration. This is because, by their very nature, most commercially valuable
fisheries are located over extensive areas, sometimes crossing national and
international boundaries. Furthermore, even in the absence of such a political
problem, the transaction costs (in particular the cost of policing violators) would
be extremely high. Thus the challenges of fishery regulations are quite formidable,
and they cannot be resolved by simply relegating the responsibilities of resource
allocation to public authorities.
1.5 LIMITATIONS OF STEADY-STATE BIO-

ECONOMIC MODEL
So far, we discussed the steady-state bio-economic model for managing the
biological resource with a focus on fishery. But there are some important limitations
of this model. They are discussed as below.
 Time: In this model, the socially optimal level of effort is shown at a given
point in time i.e. the current period. The approach is indeed static as it
considers the operation of fishery only at a single point in time. It does not
recognize that the fish population is dependent on time. To make it dynamic
and to take into consideration intertemporal allocation of fishery resources,
we need to maximize the present value of the stream of net benefits, discounted
at the social discount rate.
 Changes in prices and technology: The model discussed above assumes
constant input and output prices and no technological changes. However,
prices do indeed vary in the short-run, and change in the technology (of
catching fish) is a recurring phenomenon. An increase in output price and/or
a decrease in input price which is associated with a higher level of effort
utilization, if becomes permanent or if not temporary, the effect would lead
to overfishing. On the other hand, if technological improvement or innovation
takes place, then at each level of effort, there will be more catch than before
which cannot be sustained without negatively impacting the equilibrium
population size associated with each level of effort. Thus, other factors
remaining constant, an improvement in the technique of harvesting would
accelerate the reduction in the underlying population size of fish.
 Multiple Species Fishery: In this simple model, the fishery assumes harvesting
of only a single species. However, complications arise by additional economic
and ecological constraints, when multiple species or groups are taken into
account. From economic perspective, the cost of harvesting a particular
species may be affected by the presence of the stock of another species.
From an ecological perspective, the problem arises when selective fishing is
done on the basis of the commercial values of the species under consideration
and with no regard to the ecological dynamics of the entire fishery. In the
long run, such a practice may bring disaster.
11
Resource and Economy  The assumption of stable steady-state equilibrium: The simple bio-economic
model assumes that the natural systems tend toward a state of equilibrium.
In fact, natural systems may be characterized by constant instability. Changes
in water temperature, new predators and disease, and pollution, current and
other environmental factors are continually affecting the fish stock population
of a particular fishery system. All these calls for the continual reevaluation of
the stock of fish before each fishing season.
 The stochastic nature of fishery populations: The net growth of fish population
could be negative, if fish population is reduced below a certain threshold or
the critical zone, leading towards inevitable extinction. A small population
could be highly susceptible to demographic accidents and ecological
disturbances. This stochastic behavior of fish population involves greater
uncertainty in fisheries management.
Check Your Progress 1
Note: a) Use the space given below for your answer
b) Compare your answers with those given at the end of the unit
1. Define the renewable and non-renewable resources?
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2. Explain briefly bio-economic model of renewable resources and its limitations?
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1.6 ECONOMIC THEORIES OF NON-

RENEWABLE RESOURCES
As discussed in the preceding sections of this unit, non-renewable resources have
fixed stock. Examples of such resources are fossil fuels like oil, coal, natural gas;
metallic minerals such as iron, gold, aluminum, copper, lead; and non – metallic
mineral resources like phosphate and potash deposits. The most important feature
of these resources is that they need geological time spans to regenerate. Therefore,
for all practical purposes, the rate of stock creation over time is zero. In addition,
non-renewable resources can be classified into two categories: non-recyclable
and recyclable. Examples of non-recyclable are fossil fuels and recyclable are
metallic resources examined above. The relationship of the stock of non-renewable
resources and the flow of services that these resources provide over time can be
explained as follows:
Let’s consider S0 is the fixed stock non-renewable resource at the time of discovery.
Let St be the quality or stock of particular resource at time t and time varies from
12 0, 1,… t-1, t.
Rt be the rate of extraction or a flow of service at a time t. Economic Theories of
Renewable & Non-
Renewable Resources
By using above notations, we can easily state that in the absence of extraction and
natural process of degradation,
St = S0 (1)
The above equation states that a non-renewable stock resource is fixed amount
equal to the quantity at time of discovery. The rate of stock creation over time
is zero.
Now let’s assume the presence of a positive extraction rate per unit time of the
non-renewable resources. The relationship between the stock and service flow of
non-renewable resource can be identified by the following equation.
St = S0 - Rt (2)
The above equation indicates that stock of non-renewable resources is depleted

by the rate of extraction, Rt . This simply states that at any given point in time the
deposit of a non-renewable resource St is the difference between the quantity of
the resource at the time of discovery and the cumulative extraction to that point
in time. Moreover, the following is expected:
S0 > R t (3)
The above equation shows that the flow of services can be realized from a non-
renewable stock resource available at the time of discovery. The continuous use
of the resource can lead to exhaustion that is S0= Rt. This states the physical
concept of exhaustion. The economic concept of exhaustion will be taken up in
the next section.
Now let’s consider the recycling aspect of the exhaustible resources. Considering
the recycling aspect of the non-renewable resources can alter the one to one
relationship between physical stock and the flow of services which can be derived
from the use of exhaustible resources. This arises when the physical stock of
natural resource St is diminished by the rate of extraction, Rt, but it is also
enhanced by the rate of recycling, gt.
Then the net extraction rate per unit time is: Rt-gt.
However, it is impossible to have perfect recycling technology accruing to the

second law of thermodynamics. Thus,
R t- g t> 0 (4)
The equation (4) indicates that even with recycling characteristics, non-renewable
resources are eventually exhaustible. However, recycling can only extend the time
of exhaustion further.
1.7 OPTIMAL ALLOCATION OF NON-

RENEWABLE RESOURCES
So far, we have discussed the issue of fixed stock of non-renewable resources.
Though it is difficult to measure the current and future availability of these resources,
it is quite clear that the resources are diminished over the years through extraction
13
Resource and Economy and overexploitation. The important issues relating to the economics of non-
renewable resources generally concerns the study of the inter-temporal allocation
of these types of resources. This concept states that how much of existing non
renewable resources will be consumed by the present generation and how much
should be left for the coming generation to cater their requirements. Present use
of the resource would not prevent use of the same resource in the future only in
situations where the stock of the resources under consideration is huge or the said
resources do not deplete with their use. In other words, the cost of the present
resource by the present generation in terms of forgone future use of the same
resource is zero. Under this condition, the optimal inter-temporal use of a non-
renewable stock resource can be determined by equating the marginal social cost
and marginal social benefit in each time period independently. This kind of
situation is not relevant in the real world situation where there is no conflict over
resources between present and future generation.
In real world situation, present use and consumption of non-renewable resources

entails a cost in terms of forgone future use and consumption. The general condition
of attaining optimal inter-temporal allocation of non-renewable resources requires
the marginal net benefit from the last unit of resource consumption to be same for
the whole of the relevant time period. This implies that any deviation from this
condition would state a need for reallocation of resources. For instance, at a
certain level of resource use suppose the marginal net benefit to the present
generation is greater than the marginal net benefit to the future generation. Under
this circumstances, if the objective is to maximize total social benefit, it makes
perfect meaning to increase the consumption of non-renewable resources for the
present period. This implies that there will be a reduction in the magnitude of
availability of these resources for the future generation.
Now let’s consider a situation where some of the non-renewable resources are
recyclable. What would be the impact of recycling on the conditions for inter-
temporal allocation of non-renewable resources discussed above? Use of non-
recyclable, non-renewable resource use by present generation completely prevents
future generation to use that resource. For a non-renewable resource that is
recyclable each time a unit of the resource is used only part of it is completely
depleted and destroyed. It is to be kept in mind that hundred per cent recyclable
can be possible in the world. The partial loss of recyclable non-renewable resources
due to repeated use suggests that the marginal cost user cost is positive for non-
renewable resource. But recyclable resource is fixed in supply. Each time a unit
of resource is used by present users and some portion of that resource will never
be available for future consumption. The marginal user cost of a non-renewable
resource is to be less, if it is recyclable. One thing is very clear from the above
discussion that recycling must not be viewed as a remedy to stop the limits
imposed by nature on the future availability of exhaustive resources. It can’t
overcome the technological limits by nature (i.e., the laws of Thermodynamics rule
out 100 percent recycling). In fact recycling can prolong the use of natural
resources, but cannot create new resources. Overall, the most important effect of
recycling non-renewable resources is to ensure more availability of these resources
for present use. Moreover, the amount of natural resources that present generation
is willing to pass along for use by the future generations depends on the moral and
ethical values that the present civil society holds as a collective institution.
14
Economic Theories of
1.8 NON-RENEWABLE RESOURCES AND Renewable & Non-
Renewable Resources
LIMITS TO ECONOMIC GROWTH
It is very much clear from the above discussion that exhaustion of non-renewable
resources is accompanied by a steady rise in price. This implicitly states that
scarcity of a non-renewable resource is very much associated with rising cost of
its use. It is found that when price of a particular non-renewable resource steadily
increases, users of this resource will start searching for close substitutes in a
variety of ways. This search is facilitated greatly by continued technical progress.
For example, suppose India is currently generating most of its electricity from the
use of fossil fuels, particularly coal. As coal gets depleted, its price is expected
to increase steadily in the long term. The increase in price of coal will have
upward trend and this upward trend will not continue forever. It can be advocated
that at some price level, the use of an alternative resource such as the production
of electricity from solar or from nuclear will become economically feasible and
efficient. The growth optimists view that, some depleted resource like coal will
gradually be replaced by a virtually inexhaustible resources i.e., solar energy or
fusion energy in the long run. Therefore the economic growth may not be impeded
by the exhaustion of non-renewable resources in the long run. However, this
analysis assumes that the nature provides unlimited sink service and absorbs all
carbons emitted from the use of fossil fuels without any adverse impact on economy
which is less likely. This analysis also ignores the geospatial aspects of resource
exhaustion and its impact on economy of the country concerned. Nauru, a small
island country in Pacific Ocean, has attained economic prosperity by exploiting its
vast deposits of phosphates. The country with second highest per capita GDP in
the world has turned to destitution in recent years with the exhaustion of phosphates.
Phosphate mining in the central plateau has left a barren terrain of jagged, prehistoric
coral pinnacles, up to 15 meters (49 ft.) high. A century of mining has stripped
and devastated four-fifths of the total land area and any efforts to rehabilitate the
mined-out areas have been unsuccessful affecting the economy of the country
considerably.
1. Explain the economic theories of non-renewable resources?
.................................................................................................................
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2. Briefly elaborate the relationship between the exhaustion of non-renewable
resources and economic growth?
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Resource and Economy
1.9 LET US SUM UP
l Natural environment is a great source of food and other extractive materials
indispensible for the human economy. The renewable resources such as fish,
forests, wildlife can be preserved, developed and conserved through effective
management system. These resources are capable of self generation. They
can be depleted and degraded, if they are exploited beyond a certain critical
limit.
l Non-renewable resources are fixed in supply. In reality, it is assumed that

these resources have zero regenerative capacity.
l The persistent use of non-renewable stock resources will inevitably lead to

exhaustion. The use of a unit of non-renewable resources suggests a total
and permanent loss of future use. Recycling of these resources merely
postpones exhaustion.
l Exhaustion of mineral resources is basically an economic event because

economic exhaustion precedes geological exhaustion. In addition, the
fundamental problem of exhaustible resource is an issue of inter-temporal
allocation of infinite geological natural resources.
l The key point is how much of an exhaustible resource should be extracted

for present consumption and how much of it should be left for future use.
1.10 KEY WORDS

Inter-temporal allocation of resources: Allocation of resources between present
and future generation.
Non-Renewable resources: Those resources which are not replaceable, or

replace so slowly by natural or artificial processes that for all practical purposes,
once used they would not be available again within any reasonable time frame.
Recyclable non-renewable resources: These resources can be reused. These

include metallic resources.
Renewable Resources: Renewable resources are the resources that are capable
of regenerating themselves within a short period of time. Examples of such resources
are forests, fishes, wildlife, etc.
1.11 REFERENCES AND SUGGESTED

FURTHER READINGS
l Conrad, J. M. 2003. Resource Economics. Cambridge University Press,
Cambridge.
l Daly, H.E. and Farley, J. 2004. Ecological Economics. Principles and

applications. Island Press, Washington. p 454.
l Hussen, A. M. 2000. Principles of Environmental Economics: Economics,

16 Ecology and Public Policy. Routledge, London.pp.383.
l Kerr, J.M. and Swarup, R. 1997. Natural Resource Policy and problems in Economic Theories of
Renewable & Non-
India. In: Natural Resource Economics-Theory and Application in India. eds. Renewable Resources
Kerr, J.M., Marothia, D.K., Singh, K., Ramasamy, C. and Bentley, W.R.
Oxford and IBH, New Delhi. Pp.3-33.
l Kolstad, C.D. 2011. Intermediate Environmental Economics. Oxford

University Press, 198, Madison Avenue, New York-10016. p.470.
1.12 KEY TO CHECK YOUR PROGRESS

1. Your answer must include the following points
l Different types of renewable resources such as forest, wildlife, etc.
l Definition of non-renewable resources.
l Basic concepts of bio-economic model
l Limitations of bio-economic model include factors such as time, price,
technology, etc.
l Stock and flow concepts of non-renewable resources
l Recyclable non-renewable resources
l Relationship between technology and the stock of non-renewable
resources
l Technology can reduce the adverse impact of exhaustible resources on
economic growth
17
UNIT 2 RESOURCE EXPLOITATION
AND ENVIRONMENTAL
DEGRADATION
Structure
2.0 Introduction
2.1 Objectives
2.2 Nature of Resources
2.3 Natural Capital – Abiotic Resources
2.3.1 Fossil Fuels
2.3.2 Mineral Resources
2.3.3 Water
2.3.4 Land
2.3.5 Solar Energy
2.4 Natural Capital –Biotic Resources

2.4.1 Renewable Resources
2.4.2 Ecosystem Services
2.4.3 Waste Absorption
2.5 Man-made Capital

2.6 Let Us Sum Up
2.7 Key Words
2.0 INTRODUCTION
Ecological economists must keep the economy in its “optimal” possible size. The
most important aspect is the physical size of the economy relative to the ecosystem
that contains it. This is an ecological and economic predicament. Optimal scale
of operation is determined in the market for inputs and outputs. However, markets
do not function effectively with goods and services that cannot be exclusively
owned. Developing effective policies requires a clear understanding of the nature
of resources and natural resources provided by the ecological system to the
economic sub-system. This unit introduces several concepts that will be useful for
understanding the nature of resources.
Natural systems and economic system are interdependent. Nature provides four
classes of services to the economy namely resource inputs, life support structures
and services, waste sinks and recreation. Natural capital is as important to the
economy as the man-made capital. This unit introduces the types of natural
capital and their nature and how their sustainable use can be determined in the
economy. Man-made capital is also briefly discussed to distinguish among human
capital, intellectual capital, social capital and durable capital in manufacturing.
18
Resource Exploitation and
2.1 OBJECTIVES Environmental Degradation

l describe the nature of the resources; and
l explain the concept of natural capital and nan-made capital.
2.2 NATURE OF RESOURCES

Stock-flow and fund- service resources: We now turn our attention to an
important distinction between different types of scarce resources too often
neglected by conventional economists - that of stock-flow and fund-service.
Conventional economics uses the phrase “factors of production.” Factors of
production are the inputs into a production process necessary to create any
output. Stock and flow and the relationship between the two are fundamental to
the economic system as well as ecological system. A stock is a quantity existing
at a point of time, and a flow is a quantity per period of time. The stock and the
corresponding flow are related.
Closing Stock = Opening stock + inflow – outflow
Over any period, the change in the stock size is
St – St – 1 = At – Ot; where st is stock in period; st-1 is the stock on the
previous period; At is the closing stock in the current period and Ot is the
opening stock size
During a period, the stock will increase, accumulate, if At > Ot, while it will
decrease, de-cumulate, if At < Ot. Many of the processes in both economic
and natural systems are being analyzed in terms of this simple basic framework
of flows in and out of corresponding stocks. However, not all processes fit
this framework. A stock-flow resource is materially transformed into what it
produces. A stock can provide a flow of material, and the flow can be of
virtually any magnitude; that is, the stock can be used at almost any rate
desired. The appropriate unit for measuring the production of a stock-flow
resource is the physical amount of goods or services it can produce. Further,
a flow can be stockpiled for future use. Finally, stock-flow resources are used
up, not worn out. The stock of fossil fuels such as oil, coal, lignite and other
minerals and ores that give us metal are typical examples. Once the flow of
extraction increases, the stock gets depleted. It is irreversible in nature.
Fund-service resource, in contrast, suffers wear and tear from production
but does not become a part of (does not become embodied in) the thing
produced. Instead, a fund provides a service at a fixed rate, and the appropriate
unit for measuring the service is physical output per unit of time. The service
from a fund cannot be stockpiled for future use, and fund-service resources
are worn out, not used up, though there are a few exceptions. Labour that
enters the production processes is a fund resource. Labour does not become
a part of the thing produced. Similarly natural resources such as river water
and sun light are fund services. The flow of river water cannot be controlled
but it can be used as long as the flow continues, unless the fund is permanently
damaged. 19
Resource and Economy Excludability: Excludability is a legal concept when enforced allows an owner
to prevent others from using his or her asset. An excludable resource is one
whose ownership allows the owner to use it while simultaneously denying
others the privilege. For example, when I own a bicycle, I can prohibit others
from using it. In the absence of social institutions enforcing ownership, nothing
is excludable. However, the characteristics of some goods and services are
such that it is impossible or else highly impractical to make them excludable.
While someone could conceivably own a streetlight on a public street, when
that streetlight is turned on, there is no practical way to deny other people on
the street the right to use its light. Most of the public goods are non excludable.
There is no conceivable way that an individual can own climate stability, or
atmospheric gas regulation, or protection from UV radiation, since there is no
feasible institution or technology that could allow one person to deny all
others access. In the absence of an institution or technology that makes a
good or service excludable, it becomes a non-excludable resource.
Rival-ness is an inherent characteristic of certain resources whereby

consumption or use by one person reduces the amount available for everyone
else. A rival resource is one whose use by one person precludes its use by
another person. A pizza (a stock-flow resource) is clearly rival, because if one
eats, it is no longer available for anyone else to eat. A bicycle (a fund service
resource that provides the service of transportation) is also rival, because if
I am using it, you cannot. While you can use it after I am done. The bicycle
has worn out a bit from my use and is not the same as it was.
A non-rival resource is one whose use by one person does not affect its use
by another. If I use the light of a streetlight when riding my bike at night, it
does not decrease the amount of light available for others to use. Similarly,
if I use the ozone layer to protect me from skin cancer, there is just as much
left for others to use for the same purpose. It is possible to deplete the ozone
layer through the emission of ozone depleting substances like
chlorofluorocarbons but depletion does not occur through use. Rival-ness is
a physical characteristic of a good or service and is not affected by human
Institutions.
It is important to note that all stock-flow resources are rival in nature and all
non-rival goods are fund-service. However, some fund-service goods are
also rival. For example, my bicycle is a fund that provides the service of
transportation, but it is rival as no body can use it when I am using it. The
ozone layer is a fund that provides the service of screening UV rays, but it
is non-rival. For allocation of resources the concepts of rival-ness and
excludability are very important.
2.3 NATURAL CAPITAL – ABIOTIC RESOURCES

Goods and services provided by the sustaining system are important. We
refer to all the structures and systems that provide these goods and services
as natural capital. There are eight types of goods and services provided by
nature, divided for convenience into nonliving (Abiotic) and living (Biotic)
resources. This is too simplistic a classification, given the enormous number
20 and the complexity of resources on earth. Some of them are renewable and
others are non renewable. They are as follows. Resource Exploitation and
Environmental Degradation
Abiotic Resources
1) Fossil fuels
2) Minerals
3) Water
4) Land
5) Solar energy
Biotic Resources
1) Renewable resources
2) Ecosystem services
3) Waste Absorption.
Ecosystem services include waste absorption along with life supporting services.
However as waste absorption capacity is of unique importance for ecological
economics, it is treated separately.
Abiotic resources are either non-renewable (fossil fuels) or virtually indestructible
like water, land and solar energy. Abiotic resources are fundamentally different
from each other, and it is their even greater dissimilarity from biotic resources that
binds them together, more than their similarity to each other. Perhaps, the most
important distinction is that biotic resources are simultaneously stock- flow and
fund-service resources that are self-renewing, but human activities, can affect their
capacity to renew. Fossil fuels and mineral resources are frequently grouped
together under the classification of non-renewable.
2.3.1 Fossil fuels
For practical purposes, fossil fuels are a non-renewable source of low-entropy
energy. Fossil fuels are stock-flow resources and are rival both within and
between generations. Energy products cannot be recycled. Once the petrol is
used in a combustion engine to drive a car, the energy gets converted into heat
and gets dissipated into the atmosphere. The energy is no longer available for use.
They are also very important for economic activity. Fossil fuels not only supply
our energy needs, they also provide the raw materials for a substantial portion of
our economic production, including plastics, fertilizers, herbicides, pesticides, etc.
In geological terms and as far as humans are concerned, fossil fuels are a fixed
stock. For a variety of reasons, however, it is extremely difficult to say precisely
how large that stock is. Clearly, hydrocarbons are found in deposits of varying
quality, depth, and accessibility, and there are different costs associated with the
extraction of different deposits. In economic terms, the recoverable supplies are
those for which extraction cost is lower than the price of the fuel in the market.
However the input costs of extraction and output prices of petroleum products
change and hence the recoverable supplies vary. As we deplete the most accessible
hydrocarbon supplies first, over time it will take more and more energy to recover
remaining supplies. In other words, the ‘energy return’ on investment, which is 21
Resource and Economy “the ratio of gross fuel extracted to economic energy required directly and indirectly
to deliver the fuel to society in a useful form,” declines over time.
As new reserves are found, we may not be able completely exhaust the stocks.
But this argument is not much of a consolation to the energy hungry economy.
Easily accessible high quality reserves are extracted first, where energy gains are
the highest. Therefore, as we continue to extract fossil fuels over time, we can
expect not only a quantitative decrease but also a qualitative decline in stocks.
As stocks diminish, it takes more energy to extract one unit of energy.
Resource exhaustion is one part of the problem. The other is the generation of
waste. The used fuel does not disappear. It must return to the ecosystem as
waste. Acid rain, global warming, carbon monoxide emission, heat pollution, and
oil spills are unavoidably associated with the use of fossil fuels. On a small scale,
some of these wastes could be readily processed by natural systems, but on the
current scale of massive waste generation, they pose serious threats. Depletion
probably is a lesser problem than the waste creation to the human welfare. The
waste sink will be full far before the depletion of all stocks. If waste products
from fossil fuels diminish the ability of these ecosystems to capture energy, there
are more energy costs to fossil fuel extraction than the direct ones discussed
above.
There are other long term harmful effects from fossil fuels to the ecosystem. The
ecosystems themselves capture solar energy, and humans make direct use of
much of the energy they capture as life support. If waste products from fossil fuel
use diminish the ability of these ecosystems to capture energy, (for example
temperature rise due to green house gas emissions could reduce the yield of a
crop), the energy cost will be more. They are difficult to measure and hence often
ignored, though their impacts could be many fold larger than the measurable
problems. The basic equation here is:
Net recoverable energy from oil = (initial total stock of recoverable reserves) –
(energy cost of extraction) – (loss of solar energy due to induced loss of capacity
to capture).
Thus we must also take into account the damage caused to the ecosystem’s ability
to capture solar energy. This lost capacity is measured as energy-flow/time, and
we must account for the total amount of energy not captured from the time, the
damage occurs to the time the fund-service recovers.
2.3.2 Mineral Resources
The Earth provides fixed stocks of the basic elements in varying combinations and
degrees of purity, which we will refer to simply as minerals. This is the raw
material on which all economic activity and life itself ultimately depends. Rocks
in which specific minerals are found in relatively pure form are referred as ores.
Ores in which minerals are highly concentrated are non-renewable source of low-
entropy matter. Mineral resources are rival goods at a given point in time. If I am
using a chunk of steel as a part of my car, it is not available for others to use.
But through recycling, most of these resources could be made available for someone
else to use in the future. Thus, we can think of mineral resources as rival goods
within a generation, but as partially non-rival between generations, depending on
22 how much is wasted and how much recycled. A resource is non-rival between
generations if the use by one generation does not leave less of the resource for Resource Exploitation and
future generations.
Stocks of low-entropy mineral ores are finite but can be extracted at virtually any
rate we choose, in contrast to an oil well that cannot be controlled easily. Valuable
mineral deposits occur in varying degrees of purity, and, like fuels, the degree of
purity can be looked at as a measure of low entropy.
We could not sustain existing populations or levels of economic production in the
absence of these minerals. While it would clearly be impossible to develop
substitutes for all minerals, thus far it has been reasonably easy to develop substitutes
for specific minerals as they become scarce, and it may be possible to keep this
up for some time to come. The rate of increase in the aboveground stocks is
equal to net annual mineral extraction and aboveground stocks of minerals currently
in use plus those that can be recycled.
There are two types of wastes. Those in the form of goods that are still intact and
ordered state but discarded because of them being obsolete or out of fashion.
The other waste occurs due to chemical and physical erosion and not usable any
more. Unlike the fossil fuels, the use of minerals does not cause green house gas
emissions and damage the earth’s ability to capture the solar energy. Their use
and consequent return to the ecosystem as waste would not cause irreparable
damage as fossil fuels. Mineral deposits are sufficiently large, and recycling has
the potential to become sufficiently efficient, that with careful use, minimizing
waste and appropriate substitution where possible, we could sustain for a very
long time.
There are two types of stocks of minerals namely those which are below the earth
as subterranean stocks and those which are already extracted and reusable by
recycling. As time goes by, the extraction of subterranean stocks do not increase.
It is because the costs of extraction start increasing. On the other hand, the
above the ground usable low entropy and recyclable stocks will increase initially
but starts declining after a time as 100% recycling is not possible. Some of the
stock dissipates into waste every year and no longer available for reuse. If 100%
recycling is possible, then the two lines representing two types of stocks would
be identical. The rate of increase in the aboveground stocks is equal to net annual
mineral extraction minus entropic dissipation. Entropic dissipation is conversion of
low entropy minerals into unusable waste of high entropy.
2.3.3 Water
The Earth provides a fixed stock of water, of which fresh water is only a miniscule
fraction. All life on Earth depends on water, and human life depends on fresh
water. The stock of water on earth is finite, though, 70% of the Earth’s surface
is covered with water. Freshwater, however, is far less abundant, accounting for
less than 3% of the total, of which less than one third of 1% is in the form of
readily exploited lakes (0.009%), rivers (0.0001%), and accessible groundwater
(0.31%). Another 0.01% is found in the atmosphere, 0.31% is deep groundwater,
and over 2% is in the polar ice caps and glaciers. Humans are composed mostly
of water, and in addition to drinking, we depend on it for agriculture, industry,
hydroelectricity, transportation, recreation, waste disposal, and for sustaining the
planet’s ecosystem services.
23
Resource and Economy Water for different uses has different relevant characteristics that make generalizations
difficult. Water is a stock flow resource but it is renewable through hydrological
cycle. But for all practical purposes, the recharge rates are very low. The rate of
extraction of water from aquifers is faster than the rate of recharge. Many smaller
rivers are over utilized and never reach the sea. The water flows in the rivers and
streams make them fund services which are available at a certain rate. If dams
are constructed and water stockpiled, it becomes a stock-flow resources. Water
is used up but never wears out like other fund services. When mechanical energy
in the water is converted to electric energy by a hydro-electric power plant that
depends on river flow, it is essentially a fund-service resource.
When used for transportation, recreation, or sustaining all other ecosystems on
the planet, water functions as a fund-service resource. Atmospheric moisture, as
part of the hydrological cycle, is essentially a fund-service resource. Like biotic
resources, water can be a stock-flow and fund-service resource simultaneously.
Unlike biotic resources, however, humans cannot meaningfully affect the total
stock of water on the planet. As one would expect from its dual nature as a
stock-flow, fund-service resource, water can be rival or non-rival depending on
its use; stock-flow uses are rival, and fund-service uses are non-rival. However,
as flowing water is recycled through the hydrological cycle, it is inter-generationally
non-rival. Excludability varies dramatically depending on existing institutions, though
rainfall for all practical purposes is non-excludable by nature.
2.3.4 Land
The Earth provides a physical structure to support us that is capable of capturing
the solar radiation and rain that falls upon it. Land as a physical structure, a
substrate is capable of supporting agriculture and as a site has economic properties.
Land is a physical substrate and location, distinct from its other productive qualities
of land. Land is also a fund that provides the service of substrate capable of
supporting humans and the infrastructure. It is also capable of capturing solar
energy and rain. Land also contains and supports ecosystem. However that
property is not included in “Land” as a resource used in producing crops. A
hectare of land may be capable of producing a large amount of crop over a long
period of time but all of it cannot produce in a single year. It would not be
possible to accumulate land’s capacity as a substrate. The services provided by
land are certainly excludable, and at any given point in time, they are also rival.
For example, if used for farming, land provides the service of a substrate for
crops. If one farmer uses that service, no one else can in the same time period.
Land is rival within a generation. It is inter-generationally non-rival and absolutely
non-depletable. Soil fertility could be depleted but its physical presence as a
substrate is always there.
2.3.5 Solar Energy
The sustaining system provides solar energy, the ultimate source of low entropy
upon which the entire system depends. Solar Energy is an abiotic producer of
goods and services. Sun shines to the Earth in 19 trillion tons of oil equivalent
(toe) per year which is more than that can be found in all recoverable fossil fuel
stocks and will continue to do so for billions of years. While the flow of solar
energy is vast, it reaches the Earth at a fixed rate in the form of a fine mist, and
hence is very difficult to capture and concentrate. Most of the sunlight that strikes
24 the Earth is reflected back into space. Life has evolved to capture enough of this
energy to maintain itself and the complex ecosystems that life creates. It is not Resource Exploitation and
depletable by use. It means that one person’s use depletes the resource in question.
Hence, the ozone layer is non-depletable because if I use it to protect me from
skin cancer, it is still there for someone else to use. It is certainly possible to
deplete the ozone layer with chemicals, but that is not a case of depletion caused
by use. Virtually all energy captured from the sun is captured by chlorophyll. We
also directly use over half of the energy captured by plants. The sun unquestionably
radiates the Earth with sufficient energy to meet our needs, but how do we
capture it? Global gross energy consumption is about 9 billion tonnes per year.
Biomass, hydroelectricity, wind, photovoltaics, and wave/ocean thermal energy
are all forms of solar energy we could potentially capture. Biomass is widely
touted as a substitute for fossil fuels, but as we saw previously, converting all of
the net primary productivity (NPP) of the United States to liquid fuel would still
not meet our liquid fuel needs. Hydroelectricity currently provides 19% of global
electricity, but even fully developed it could not supply 60%. Wind currently
supplies little energy (about 17,500 MW in 2000), but it is a promising alternative.
Sun light for practical purposes is a fund-service resource that arrives on the
Earth’s surface at a fixed rate and cannot be effectively stored for later use.
Table 2.1 : Selected Policy Relevant Characteristics of A-biotic Resources
Stock-Flow Can Be Rival
Abiotic or Fund- Made Be twe en
Resources Service Excludable Rival Generations Substitutability
Fossil Fuels Stock-flow Ye s Ye s Ye s High at margin,

(non-recyclable) time is important
factor, but possibly
substitutable
Minerals Stock-flow Ye s Ye s Partially High at margin,

(partially ultimately
recyclable) Non-substitutable
Water Context- Context- Context- Stocks, yes; Non-substitutable

(solar recycling) dependent dependent dependent funds and for most
recycled, no important uses
Land Fund-service Ye s Ye s No Non-substitutable

(indestructible)
Solar Energy Fund- No No, for No Non-substitutable

(indestructible) service practical
purposes
Source: Daly and Farley (2004)

1. What is excludability?
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2. What do you know about natural capital?
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2.4 NATURAL CAPITAL – BIOTIC RESOURCES
2.4.1 Renewable Resources
Only photosynthesizing organisms are capable of harnessing the energy in the
sunlight directly, and virtually all other organisms, including humans, depend on
these primary producers. These biological resources are traditionally referred to
as renewable resources. For simplicity, we can treat biological resources as material
stock-flow resources. Functions of the ecosystem though cannot be separated
from the structure, are considered separately, due to their special importance to
economic activity. Like non-renewable resources, biological stocks can be extracted
as fast as human beings desire, but they are capable of reproduction. They are
only renewable, if extracted more slowly than the rate at which they reproduce.
If ecosystem structure changes, the functioning changes. For example, forest is a
biotic renewable resource. Forests absorb up to 90% of the solar energy that
strikes their canopies. Much of this is released through evapo-transpiration and
carried high up into the atmosphere, where it is carried into the temperate zones,
helping stabilize the global climate. The species and populations in the forest
cannot survive without a stable climate and a steady nutrient flow. Loss of forest
structure can degrade forest function to the point where the forest spontaneously
declines, creating a positive-feedback loop with potentially irreversible and
catastrophically negative consequences. Computer models suggest that regional
climate change following extensive deforestation prevent the re-growth of the
forest.
Sustainable extraction
As most people are aware, stocks of plants and animals in nature cannot grow
forever. Instead, populations reach a point where they fill an available niche, and
average death rates are just matched by average birth rates. At carrying capacity,
there is just enough food and habitat to maintain the existing population and the
rate of growth in biomass is zero. The rate of growth of a stock is also zero when
the stock has been driven extinct.
Fig. 2.1: Sustainable Extraction

We can depict a renewable natural resource in a graph to show the levels
of sustainable harvest or extraction. In the fig 2.1 on Sustainable Extraction, the
X-axis depicts the stock, or amount of resource that exists, and the Y-axis depicts
the flow. The flow in this case can be the rate of reproduction (or biomass
increase) that is likely for any given stock, or the rate of extraction (harvest). The
45-degree dashed line shows the theoretically maximum rate at which we can
26 extract a given stock (i.e., we can extract the entire stock at one time; stock =
flow). Actual extraction rates must lie on or below this line. The growth, or Resource Exploitation and
sustainable yield curve for a renewable natural resource indicate the increase in
stock over one time period for any given stock. The Y-axis can measure growth
or harvest, that is, flows from or to the existing stock depicted on the X-axis. Any
harvest up to the total stock is theoretically possible. A harvest at any point on
the sustainable yield curve, such as S, is just equal to the growth in the stock, and
hence has no net impact on stocks.
Harvests above the sustainable yield curve deplete the resource, and harvests
below the curve lead to an increase in the stock, as indicated by the arrows. For
example, a harvest at R will reduce the stock to S’’, and harvest at S’ will allow
the stock to increase to R’’. CD represents the critical dispensation level, which
is the level below which a species or stock cannot sustain itself even in the
absence of harvest. The critical dispensation level is equivalent to the minimum
viable population. “K” represents the carrying capacity. The graph suggests
extremely rapid growth rates—about 30% per time period at maximum sustainable
yield (MSY), which is the average maximum harvest that can be removed under
existing environmental conditions over an indefinite period without causing the
stock to be depleted, assuming that removals and natural mortality are balanced
by stable recruitment and growth. While this may be appropriate for small, rapidly
reproducing species, growth rates for many economically important species are
on the order of 1% per year or less. The curve that shows the growth rate of
each level of stock is also the sustainable yield curve. The sustainable yield is the
net annual reproduction from a given stock. For every population of a resource,
there is an associated average rate of population increase, and that increase
represents a sustainable harvest that can be removed every year without affecting
the base population. For example, a harvest at point R would reduce the population
to stock S’’. At S’’, per-capita resource abundance would be even greater than
at R’’, increasing net annual growth and sustainable harvest from R’’ to S. Over
a certain range, lower population stocks can generate higher sustainable yields,
but this obviously cannot go on forever. Eventually, the breeding population is
insufficient to sustain high yields. This means that at some point, there is a maximum
sustainable yield, MSY. The analysis applies to fish, plants and animal populations,
with some modifications based on the type of harvest.
2.4.2 Ecosystem Services
Living species interact to create complex ecosystems, and these ecosystems generate
ecosystem functions. When functions are of use to humans, we refer to them as
ecosystem services. Many of these ecosystem services are essential to our survival.
Ecosystem functions include such things as energy transfer, nutrient cycling, gas
regulation, climate regulation and the water cycle.
Ecosystems are extraordinarily complex and dynamic, changing over time in
inherently unpredictable ways. Intact ecosystems are funds that provide ecosystem
services, while their structural components are stocks that provide a flow of raw
materials. Unlike man-made fund resources, ecosystems do not “wear out.” The
fact is, however, that ecosystems would “wear out” if they did not constantly
capture solar energy to renew themselves. Ecosystem services are fundamentally
different. We cannot use climate stability at any rate we choose— for example,
drawing on past or future climate stability to compensate for the global warming
we may be causing today. Nor can we stockpile climate stability for use in the
future. Seventeen different goods and services generated by ecosystems are given
in table 2.2.
27
Resource and Economy Table 2.2 : Examples of Services Provided by Ecosystems
Ecosystem Examples from Forests
Service
Gas regulation Trees store CO2 and growing trees create O2; forests
can clean SO2 from the atmosphere.
Climate regulation Greenhouse gas regulation; evapotranspiration and
subsequent transport of stored heat energy to other
regions by wind; evapotranspiration, cloud formation,
and local rainfall; affects of shade and insulation on
local humidity and temperature extremes.
Disturbance Storm protection, flood control (see water regulation),
regulation drought recovery, and other aspects of habitat response
to environmental variability mainly controlled by
vegetation structure.
Water regulation Tree roots aerate soil, allowing it to absorb water
during rains and release it during dry times, reducing
risk and severity of both droughts and floods.
Water supply Evapotranspiration can increase local rainfall; forests can
reduce erosion and hold stream banks in place,
preventing siltation of in-stream springs and increasing
water flow.
Waste absorption Forests can absorb large amounts of organic waste, and
capacity filter pollutants from runoff; some plants absorb heavy
metals.
Erosion control and Trees hold soil in place, forest canopies diminishes
sediment retention impact of torrential rainstorms on soils, diminish wind
erosion.
Soil formation Tree roots grind rocks; decaying vegetation adds
organic matter.
Nutrient cycling Tropical forests are characterized by rapid assimilation
of decayed material, allowing little time for nutrients to
run off into streams and be flushed from the system.
Pollination Forests harbor insects necessary for fertilizing wild and
domestic species.
Biological control Insect species harbored by forests prey on insect pests.
Refugia or habitat Forests provide habitat for migratory and resident
species, create conditions essential for reproduction of
many of the species they contain.
Genetic resources Forests are sources for unique biological materials and
products, such as medicines, genes for resistance to
plant pathogens and crop pests, ornamental species.
Recreation Eco-tourism, hiking, biking, etc.
Cultural Aesthetic, artistic, educational, spiritual and/or scientific
values of forest ecosystems.

28
We can say with reasonable confidence that the larger an ecosystem fund and the Resource Exploitation and
better its health, the more services it is likely to generate. As we deplete or
degrade a complex ecosystem fund, we really cannot predict all the impacts with
any reasonable probability. Large tropical forests can regulate climate at the local
level, the regional level, and the global level. Flood control and water purification
provided by forests may only benefit select populations bordering the rivers and
floodplains, and the provision of habitat for migratory birds may primarily benefit
populations along the migratory pathways. Most important, it is unlikely that we
can develop substitutes for most of these services, including their providing suitable
habitat for humans. Many ecosystem services (though certainly not all) are non-
excludable by their very nature as well.
The relationship between natural capital stock-flow and fund-service resources
illustrates one of the most important concepts in ecological economics. “All
economic production requires a flow of natural resources generated by a stock
of natural capital”. This flow comes from structural components of ecosystems,
and the biotic stocks are also funds that produce ecosystem services.
Therefore, an excessive rate of flow extracted from a stock affects not only the
stock and its ability to provide a flow in the future, but also the fund to which the
stock contributes and the services that fund provides. Even abiotic stocks (i.e.,
mineral elements and fossil fuels) can only be extracted and consumed at some
cost to the ecosystem. In other words, production requires inputs of ecosystem
structure. Ecosystem structure generates ecosystem function, which in turn provides
services. All economic production thus has an impact on ecosystem services, and
because this impact is unavoidable, it is completely internal to the economic
process.
2.4.3 Waste Absorption
Ecosystems process waste, render it harmless to humans, and, in most cases,
again make it available to renewable resource stocks as a raw material input. This
is really a specific type of ecosystem service, but one whose economic
characteristics make it worth classifying on its own.
The laws of thermodynamics ensure that raw materials once used by the economic
system do not disappear but instead return to the ecosystem as high-entropy
waste. They also ensure that the process of producing useful (ordered) products
also produces a more than compensating amount of disorder, or waste. Much of
this waste can be assimilated by the ecosystem. Indeed, waste assimilation and
recycling are ecosystem services on which all life ultimately depends. However,
as a fund-service, waste absorption occurs only at a fixed rate, while conversion
of stock-flow resources into waste occurs at a rate we can choose. Waste
absorption capacity is a sink for which we have control over the flow of waste
into the system but not over the size of the waste assimilated and rendered
harmless. The removal of ecosystem structure also affects the ability of the
ecosystem to process waste. If we discharge waste beyond the ecosystem’s
capacity to absorb it, we can reduce the rate at which an ecosystem can absorb
waste, which makes the waste accumulate more quickly. In time, the waste
buildup will affect other ecosystem functions, though we cannot always predict
which of the services will be affected and when. The system collapses just prior
to the point where waste flows exceed the waste absorption. In contrast to many 29
Resource and Economy ecosystem services, waste absorption capacity is rival in nature. If we dump
pollution into a river, it reduces the capacity of the river.
In general, ecosystems have a greater ability to process waste products from
biological resources, and a much more limited capacity to absorb man-made
chemicals created from mineral resources. As the economy expands, it depletes
non-renewable resources, displaces healthy ecosystems and the benefits they
provide, and degrades remaining ecosystems with waste outflows. The success of
the market system reduced the relative scarcity of market goods and increased
that of non-market goods and services provided by the sustaining ecosystem. The
nature of the biotic resources is given in table 2.3
Table 2.3 : Economic Characteristics of Biotic Resources
Biotic Stock- Can Be Rival Rival Substitut-
Resources Flow or Made Between ability
Fund- Excludable Genera-
Service tions
Renewable Stock-flow Yes Yes Depends High at
Resources rate of use margin
ultimately
non-
substitutable
Ecosystem Fund- No For No Low at
services service most, margin,
no non-
substitutable
Waste Fund- Yes Yes Depends Moderate
Absorption service on rate at margin,
of use non-
substitutable

1. What is ecosystem structure?
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2. What do you know about ecosystem services?
.................................................................................................................
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30
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3. What is waste absorption capacity? Resource Exploitation and
.................................................................................................................
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2.5 MAN-MADE CAPITAL

It is important to distinguish between natural capital and man-made capital, though
we are essentially concerned in ecological economics about the natural capital.
Capital stock in economics is labeled as K, the services that it provides is the flow
I, for investment per time period. The common equation in economics is as
follows:
K t = K t  1 + It  Dt
Where, D stands for depreciation, the amount by which the stock would diminish,
if there were no investment, I. I is a flow into K, D is a flow which diminishes
K.
The economy’s capital stock has four component parts:
1) The collection of durable equipment for use in production namely tools,
machinery, buildings, vehicles, roads, etc. This component of the total capital
stock is generally referred to as durable capital in manufacturing.
Investment in it involves using labour, capital, and natural resources to produce
such equipment rather than to produce commodities for consumption. In use,
equipment wears out, and the amount by which it does so is the depreciation
of durable capital.
2) The second component is known as human capital and consists of the
stocks of learned skills, embodied in particular individuals, which enhances
their productivity as suppliers of labour services. As with durable capital,
investment in human capital involves using inputs to acquire and disseminate
skills, education and training. The individuals in whom human capital is
embodied wear out, die, but culture means that they can pass on their
acquired skills to other individuals.
3) The third component is intellectual capital which is the accumulated
knowledge and skills available to the economy that is not embodied in
particular individuals, but resides in books and other cultural artifacts such as
computer memories. As with durable capital, so investment in intellectual
capital involves using inputs to produce knowledge and disseminate it, rather
than to produce commodities for consumption. While equipment necessarily
wears out with use, this does not have to be true of knowledge. The books
and the like in which intellectual capital is encoded may wear out, but can
be replaced. In fact, any depreciation of intellectual capital as such is on
account of non-use rather than use. Non-use leads to forgetting, which in this
context is what depreciation is.
4) The fourth component is social capital which is the set of institutions and
customs which organize economic activity. Investment in this kind of capital
is using inputs which could otherwise be used to produce commodities for 31
Resource and Economy consumption to organize and run institutions — activities such as politics,
legislation, and law-enforcement. Institutions and customs do not ‘wear out’,
but may become obsolete as circumstances change. Collectively these four
are sometimes referred to as reproducible or human-made capital.
2.6 LET US SUM UP

l Stock and flow and the relationship between the two are fundamental to the
economic system as well as ecological system. A stock is a quantity existing
at a point of time, and a flow is a quantity per period of time.
l A stock-flow resource is materially transformed into what it produces. A
stock can provide a flow of material, and the flow can be of virtually any
magnitude; that is, the stock can be used at almost any rate desired. A flow
can be stockpiled for future use. Stock-flow resources are used up, not
worn out. Once the flow of extraction increases, the stock gets depleted. It
is irreversible in nature.
l Goods and services provided by the sustaining system are important. All the
structures and systems that provide these goods and services are referred to
as natural capital. There are eight types of goods and services provided by
nature, divided for convenience into nonliving (Abiotic) and living (Biotic)
resources.
l Ecosystems are extraordinarily complex and dynamic, changing over time in
inherently unpredictable ways. Living species interact to create complex
ecosystems, and these ecosystems generate ecosystem functions. When
functions are of use to humans, the services are referred as ecosystem
services. Many of these ecosystem services are essential to our survival.
Ecosystem functions include energy transfer, nutrient cycling, gas regulation,
climate regulation and the water cycle.
l Intact ecosystems are funds that provide ecosystem services, while their
structural components are stocks that provide a flow of raw materials.
2.7 KEY WORDS

Abiotic resource: A nonliving resource that cannot reproduce. e.g. fossil fuels,
minerals, water, land, and solar energy.
Biotic resource: A living resource, such as trees, fish, and cattle as well any of
the fund-services they provide, such as climate regulation, water regulation, and
waste-absorption capacity.
Rivalness: An inherent characteristic of certain resources whereby consumption
or use by one person reduces the amount available for everyone else.
2.8 REFERENCES AND SUGGESTED FURTHER

READINGS
l Common, M. and Stagl, S. 2005. Ecological Economics: An Introduction.
Cambridge University Press, Cambridge. pp 560.
l Costanza, R., D’arge, R., Groot, R.D., Farber, S., Grasso, M., Hannon, B.,
32 Limburg, K., Naeem, S., O’Neill, R.V., Paruelo, J., Raskin, R.G., Sutton,
P. and Van den belt, M. 1997. The value of the world’s ecosystem services Resource Exploitation and
and natural capital. Nature. 387: 253 - 260.
Applications. Island Press, Washington. p 454.
University Press, 198, Madison Avenue, New York-10016. P.470.

l Excludability is a legal concept when enforced allows an owner to
prevent others from using his or her asset.
l An excludable resource is one whose ownership allows the owner to
use it while simultaneously denying others the privilege.
l In the absence of social institutions enforcing ownership, nothing is
excludable.
l Most of the public goods are non-excludable.
l Stocks or funds provided by nature that yield a valuable flow into the
future of either natural resources or natural services.
Check your Progress 2
l Ecosystem structure refers to the individuals and communities of plants
and animals of which an ecosystem is composed, their age and spatial
distribution, and the abiotic resources present.
l The elements of ecosystem structure interact to create ecosystem
functions as emergent properties generated of such a large complex
system.
l Ecosystem services are the ecosystem functions which are valuable
to humans.
l It includes functions like energy transfer, nutrient cycling, gas regulation,
climate regulation and the water cycle.
l Waste absorption capacity is the capacity of an ecosystem to absorb
and reconstitute wastes into usable forms through biogeochemical cycles
powered by the sun.
l This capacity is a renewable resource that can be overwhelmed and
destroyed, or used within sustainable limits.
33
UNIT 3 MARKET, TRADE AND
ENVIRONMENT
Structure
3.0 Introduction
3.1 Objectives
3.2 Market, Functioning and Efficiency
3.3 Market Failure, Externalities and Inefficiency
3.4 Market Failure, and Public Goods and Inter-temporal Allocations
3.5 Markets, Internationalization and Environment
3.6 Market, Globalization and Environmental Degradation
3.7 Let Us Sum Up
3.8 Key Words
3.0 INTRODUCTION
Markets are the dominant form of economic organization in modern societies. The
main purpose of this unit is to explain how markets work and how the market
determines the levels of production. It explains what Market efficiency is and
under what circumstances market brings about the best possible outcome. This
unit also explains how the market outcomes are not always the desirable ones for
environmental protection. Sometimes, markets fail to consider all the costs to
bring about optimal level of production which is environmentally sustainable. Market
failure occurs more in the case of public goods, which are not often excludable
in nature. It explains the consequences of market failure and the adverse externalities
of economic activity. The unit shows the economics of waste generation. The unit
also deals with the concepts of private costs and social costs and ways of
internalizing the externalities and correcting some of the market failures. The unit
considers the impacts of international trade and globalization on resource exploitation
and waste generation under the market conditions.
3.1 OBJECTIVES
l underline the basic principles of neoclassical economics, with respect to
market equilibrium and market behavior; and
l explain the impacts of international trade and globalization on sustainability of
resource extraction.
3.2 MARKET, FUNCTIONING AND EFFICIENCY

The economic problems of a human society are often stated in three questions as
to what to produce, how to produce and for whom to produce. In a command
economy, the authorities answer these questions. In a pure market economy,
34 where the decision making is not controlled by any single agent, decisions are left
to the individuals who own the firms. However none of the economies are pure Market, Trade and
Environment
market economies in the world. Yet barring defense, public health, law and order
and a few specific areas of the economy, most of the production and distribution
in most of the modern economies are left to the individual firms and the consumers
of the commodities and services. Firms produce commodities and services by
using the factors of production namely land, labour, capital and entrepreneurship
owned by individual members of the society and pay them factor incomes.
Individuals use the income to buy the goods and services produced by the firms.
A market is a system in which buyers and sellers of something (commodity or
service) interact. At one time, the interaction necessarily involved buyers and
sellers physically coming together, and a market was a place where they met.
Physical meeting is not necessary but interaction is important. Some markets
today, for example, involve transactions effected via the internet. A market is a
system in which buyers exchange money for something, and sellers exchange that
something for money. Rather than a place, it can be thought of as a set of
arrangements that makes such exchanges possible. The range of things bought
and sold in markets is very wide, from titles to property through iron ore to
haircuts. Market participants, as both buyers and sellers, can be individuals, firms
and governments. We will look at the market for a commodity produced by firms
and bought by individuals.
Fig. 3.1: Demand, Supply and Equilibrium

(Source: Daly and Farley, 2004)
Then there exists (at least in theory) a competitive general equilibrium, where the
markets for all outputs and inputs are in equilibrium- a state in which what is
supplied is equal to what is demanded in all markets in the economy at the
prevailing prices (fig. 3.1). In such a situation, there will be efficiency in the
allocation of resources. It would result in Pareto-efficient situations or Pareto-
optimal allocations in which it is impossible to make one person better off without
necessarily making someone else worse off.
In a free market, the price of a good reflects the money value of it to consumer
of an additional unit that is its marginal utility (MU). Similarly, if market mechanism
is working well, the marginal cost (MC) measures the value of opportunity cost
of the resources needed to an additional unit of that good. Hence, if prices are
set equal to marginal cost, then consumers by using their own money in most
effective way, to maximize their own satisfaction, will automatically be using society’s
resources in the most effective way. 35
Resource and Economy In other words, as long market sets the prices equal to marginal costs, the market
mechanism automatically satisfies MC=MU rule for efficient resource allocation.
The goal of the decision on output quantities is to maximize the total benefit or
total utility to the society minus the total cost to the society of producing the
output quantities that are chosen. In other words, we want to maximize the
surplus gained by the society, given by total utility minus total cost. In order to
maximize the total difference between the total cost and total utility or total
benefit, we must find the output that makes the marginal utility or marginal benefit
and marginal cost equal to each other. This is the rule of efficiency. Let us see
why this rule must be satisfied.
Under perfect competition, the market can gravitate to a price where the consumers
demand what the producers supply and derive the maximum satisfaction. The
firms supply what the consumers demand and maximize their profits. At that price,
marginal cost will be equal to the marginal revenue or price which is equal to the
marginal utility of the consumer. The efficient allocation of resources requires that
each product’s price be equal to the marginal cost (P=MC). The consumer
satisfaction will be the highest when the price is equal to the marginal utility to the
consumer (MU=P). Equilibrium market clearing price is that where MC=P=MU.
The equi-marginal principle of maximization tells the consumer when to stop
buying and the producer when to stop producing. We shall illustrate it further.
The principle of diminishing marginal utility that applies to the consumer tells us
that the total utility of the consumer will increase though the marginal utility would
fall with each additional unit of the commodity consumed. (The downward sloping
marginal utility curve is the demand curve of the consumers for a particular
commodity or service). When does a consumer stop reallocating her income
among different goods? When she has found an allocation that maximizes her total
satisfaction or total utility. That point occurs when the marginal utility per dollar
spent on each good is equal. To maximize pleasure, the last dollar spent on
commodity “A” must supply the same pleasure as the last dollar spent on commodity
“B”. Also at that price, the marginal utility of the commodity is equal to the price
of that good. If utility is lower than the price, the consumer can get more utility,
by buying more. Similarly if the price is higher than the value of marginal utility she
can cut down the consumption where the marginal utility will be higher to match
the price.
The firms use factors of production. The value of the marginal physical product
of a variable factor is the extra output produced as a result of using one more unit
of the variable input, all other inputs remaining constant. The principle of marginal
cost based on diminishing marginal productivity of a variable factor tells us that
the marginal cost increases with each additional unit of the commodity produced.
In fact, under perfect competition, the marginal cost curve is the same as the
upward sloping supply curve of the firm. For the producers under perfect
competition, when all the firms are price takers and not price setters, the profit
maximization condition is MC= MR=P, where P is the price per unit or its
marginal revenue, the additional revenue received for the last unit sold. Under
perfect competition, the price is fixed and does not change with amount sold or
brought. If the marginal cost of the good was less than the price, the marginal
revenue, the producer is stopping short of maximizing the profit. He can produce
36 one more unit and get more revenue with less cost. If marginal cost is greater than
marginal revenue, he must cut back on production to cut losses. Under perfect Market, Trade and
Environment
competition, the lure of profit makes the producers equate marginal cost to marginal
revenue or price. The supply continues till MC=P.
Putting the two equations together, we get MC=P=MU. If MC and MU are
equated to P, then MU=MC under perfect competition. Thus P makes the quantity
supplied equal to quantity demanded. MC=MU is the rule of efficiency. It achieves
the optimal allocation in at a point which is preferred by the society. If the price
of a commodity is above its marginal cost, the economy will tend to produce less
of that item than the amount necessary to maximize the benefit to the consumer.
For better understanding, we may use the word marginal benefit instead of marginal
utility
Hence as long as the marginal cost is lower than the value of the marginal utility
or marginal benefit, it is worthwhile consuming more as the total utility or benefits
goes up for a small addition to the cost that brings higher value of utility or benefit.
By expanding the output by one more unit, the society gets a higher total utility
value or benefit compared to the cost paid for that unit. By not expanding
production the society is missing an opportunity of getting more welfare or higher
utility and the allocation is not optimal. When Marginal cost exceeds the marginal
utility or marginal benefit, the society loses with every extra unit produced. At
MC=MU, the resource allocation is optimal to the consumer and the society. The
problem with this neoclassical theory of market efficiency is that a number of
assumptions do not hold good in the real world situation, including perfect
competition. Monopolies and oligopolies also lead to inefficient allocation of
resources. Patents are also monopolies of knowledge.
3.3 MARKET FAILURE, EXTERNALITIES AND

INEFFICIENCY
There can be instances where the market mechanism may set wrong prices. In
such instances, the resources will be misallocated. Market failures are least obvious
but most consequential of the imperfections of the price system. Many economic
activities provide incidental benefits and incidental harm to others for whom they
are not specifically intended. For example, independent house owners of a colony
that maintain beautiful front and backyards gardens full of greenery provides
unintended pleasures and clean air to those who pass by. Home owners do not
receive payment from those who pass by. This is an example of positive externality.
Similarly, there are activities that indiscriminately imposed costs on others. Operator
of an automobile repair shop from which noises, chemicals, polluted air and water
emanate, creates noises of tinkering work and harmful air to all those who pass
by and the neighbouring locations. The automobile repair shop does not pay any
compensation to those affected adversely. This is an example of negative externality.
An activity is said to generate beneficial or detrimental externality if that activity
causes incidental benefits or damage to others. No compensation is received by
those who create positive externality and no payment is made by those who
create negative externality.
In the presence of externalities, the price system misallocates the resources.
Normally the market system achieves efficiency by rewarding producers who
serve the consumers well – that is produce at as low cost as possible. The
argument of the market system breaks down, as soon as some of the costs and
benefits of economic activities are left to out of the profit calculation. When a firm 37
Resource and Economy pollutes a river, it uses up some of the society’s resources, just as surely as it uses
the material input such as iron. However the firm pays for iron but does not pay
for dirtying the clean water. Hence the management will be economical with the
use of iron but not with keeping the river water clean. While iron is private
property that has to be purchased and paid for, the water ways are public
properties and payment is not required to use them for dumping the waste. The
dissolved oxygen in the river water declines with pollution left into the river but
no body pays for the dissolved oxygen in the river water.
Now, we can say why the externalities have undesirable effects on the allocation
of resources and functioning of the markets. In discussing negative externalities,
one has to distinguish between private costs and social costs. Marginal social cost
has two components namely Marginal private cost and Incidental costs. Marginal
private cost (MPC) is the share of the marginal cost paid for the production of
an additional output by the producers involved in the economic activity. Incidental
cost is the cost borne by the others who are not involved in the production
activity, but suffer from the negative externality caused by the production activity
of the firm (fig. 3.2). If the increased output of a firm increases the smoke from
the factory, the costs incurred by other would be costs such as laundry bills, long
term and short term diseases suffered and the cost of treatment, the unpleasantness
of living in a smoky area, cost of air-conditioning for homes, the extra electricity
consumed and so on. Thus for a polluting firm that generates detrimental
externalities, its marginal social cost will be greater than its marginal private cost
(MSC > MPC). In equilibrium, market will yield an output at which consumer’s
marginal utility is equated to the firms marginal private cost. MPC=MU. It follows
that the marginal utility will be smaller than the marginal social cost. Thus the
output will be higher than the optimal output. Society will benefit if the output of
the product is reduced till marginal social cost equals the price of the output. This
can be illustrated with a graph. As shown in the graph, the original output is
higher than socially optimal output which is shown as the new output in the graph.
It is possible to correct the situation by imposing a tax on the polluting firm to
bring the total cost to the firm as high the actual social marginal cost. Then the
new output will be socially optimal. Hence externalities lead to market failures and
a variety of corrections are needed. The various instruments used are illustrated
in Block four on Valuation and Policy instruments.
38 Fig. 3.2: Social Cost

The Economics of waste generation Market, Trade and
Environment
We may think that only the private firms over exploit resources and pollute the
environment. While business firms do their share of harm, to the environment, the
individuals and the governments have also been major contributors. Emissions
from the private cars, burning of wood, plastic thrown, garbage and waste water
produced by the individual are harmful to nature. Governments too add to the
problem. The wastes of municipal treatment, atomic wastes, and chemical wastes
of defense are equally dangerous. Governments also construct giant dams and
reservoirs, and canal systems that destroy forests, submerge lands, degrade soils.
As long as human race exist, there will be production and waste generation. But
the real issue is whether environmental damage in an unregulated market economy
tends to be more serious and wide spread.
Economists do not claim any special ability to judge what is good for the public.
People’s wishes are accepted as public interest. The demand for garbage removal
is a downward sloping curve, meaning there by, if price of garbage removal goes
up, people would demand less garbage to be removed. They may recycle the
waste or they may repair the damaged things and use if they have to pay a high
price for removal of garbage. There is also a supply curve of a market for
garbage. The market’s long run supply curve is the same as the average cost
curve of garbage removal. If suppliers has to pay the full cost of garbage
generated, including the pollution created during garbage disposal, the supply
curve would be upward sloping and larger the garbage higher the cost to the
garbage generator. The price of garbage removal would be P dollars per ton per
year at the intersection of the demand and supply curve (fig 3.3). Generation of
garbage and the demand for removal would settle at an equilibrium price per ton
per year.
However, if the government decides to remove the garbage for free, (though the
taxes are collected indirectly without any direct relation to the garbage generation
and disposal, the cost of garbage generation will be zero and supply curve will
be horizontal and merges with the x axis. Then the amount generated will be the
point where the demand curve touches the x axis. Obviously, waste generation
would be far higher.

S
D
A
P
S
E

0 Q
Quantity of garbage
Fig. 3.3: Prices and Volumes of Garbage 39

3.4 MARKET FAILURE AND PUBLIC GOODS
AND INTERTEMPORAL ALLOCATIONS
Public goods
The nature of the good is important for market efficiency. An excludable good is
one for which exclusive ownership is possible; that is, a person or community
must be able to use the good or service in question and prevent others from using
it, if so desired. Excludability is virtually synonymous with property rights. If a
good or service is not owned exclusively by someone, it will not be efficiently
allocated or produced by market forces. The reason for this is obvious. Market
production and allocation are solely dedicated to profits. Goods and services
become excludable by the institutions that impose property rights. A second
characteristic that a good or service must have if it is to be efficiently produced
and distributed by markets is rivalness. We defined a rival good or service as one
for which use of a unit by one person prohibits use of the same unit at the same
time by another. Rivalness may be qualitative, quantitative, or spatial in nature.
Note that all stock-flow resources are quantitatively rival. If I eat food (a stock),
there is less for you to eat. In contrast, fund-service resources may be rival or
non-rival. When a fund-service is rival, it is spatially rival at each point in time and
qualitatively rival over time. What happens when goods and services are non-
rival, non-excludable, or both? The simple answer is that market forces will not
provide them and/or will not efficiently allocate them. Open access goods and
services also cannot be allocated efficiently by the market. As most economists
readily admit, the market is not capable of optimally producing or efficiently
allocating pure public goods, which are both non-rival and non-excludable.
These ecosystem services are primarily public goods. Let us suppose that the
ecosystem of a forest on the slopes of a hill in a developing country has been
valued at $1660/year. If a poor tribal farmer with no other means of livelihood
goes to this forested land and deforests the land, he may make a one-time profit
of $100/hectare for the timber (the timber is, of course, worth much more on the
market, but the market is far away, and middlemen and transportation costs eat
up the profits) and an estimated $33 annualized net profits per year from slash
and burn farming. In terms of society, there is no doubt that the annual flow of
$1660/year far outweighs the private returns to the farmer. However, the ecosystem
services are public goods that the farmer must share with the entire world, and
there is no realistic way of giving the farmer or anyone else meaningful private
property rights to the ecosystem services his forests supply. The farmer is not
compensated for the preserving the forest and its ecosystem services, though for
as small of $150 or less he would preserve ecosystem worth $1660/-. In
contrast, the returns to timber and agriculture are market goods that the farmer
keeps entirely for himself, and existing institutions give him the right to do as he
pleases with his private property. Clearly, both the farmer and society could be
better off, if the beneficiaries of the public goods paid the farmer to preserve
them. As long as the farmer receives more than $150/year he is better off, and
as long as global society pays less than $1660/ha/year, it is better off. Unfortunately,
a number of serious obstacles prevent this exchange from happening, and we’ll
mention three. First, most people are ignorant about the value of ecosystem
services. Second, the free-rider effect means that many beneficiaries of public
goods will pay little or nothing for their provision. Third, we currently lack institutions
40
suitable for transferring resources from the beneficiaries of ecosystem services to Market, Trade and
Environment
the farmer who suffers the opportunity cost of not deforesting. Thus, from the
farmer’s point of view, in a market economy, deforestation is clearly the rational
choice, and society suffers as a result. The public good problem appears to be
beyond the scope of market allocation.
Inter-temporal Allocation
Do conventional economists really ignore future generations? In a standard economic

analysis, where they have to compare costs and benefits in the future with costs
and benefits in the present, conventional economists will systematically discount
any costs and benefits that affect future generations. There are some very plausible
reasons for giving less weight to resources in the future than resources in the
present. The conventional economics of inter-temporal discounting can affect
decisions concerning natural resource use. When evaluating present and future
values, inter-temporal discounting is the process of systematically weighting future
costs and benefits as less valuable than present ones.
Why should resources in the future be worth less than resources today? If I have
$100 today, I can invest it in some profit-making venture, and I will have more
than $100 next year. In perhaps the simplest example, if I can safely invest money
in the bank at 5% real interest (i.e., at an interest rate 5% greater than inflation),
then I will always prefer $100 today to anything less than $105 a year from now
for the simple reason that if I have the money today, I have the option to spend
it now or allow it to become $105 next year. Next year, of course, I would again
have the option to spend the money, or leave it again to grow at 5% to become
$110.25, then $115.76, then $121.55, and so on indefinitely. Conversely, $100
in the future is worth less than $100 today because of the opportunity cost
involved (the lost opportunity to invest), and the farther in the future we look, the
less the money is worth. Most conventional economists assume that money is an
adequate substitute for anything, and therefore anything in the future is worth less
than the same thing today. In general, the present value (PV) of a sum of money
t years in the future, Xt, when the interest rate is r, will be given by
PV = Xt /(1 + r)t (1)

If we have a stream of money at different dates in the future, we can calculate
the PV for each yearly amount, and sum them. This is basically what is done in
the more complicated formula below. A standard cost-benefit analysis (CBA) will
tell us the net present value (NPV), the value to us today of a given stream of
costs and benefits through time. The farther off in time that a cost or benefit
occurs, the more we discount its present value. The basic equation is:
NPV =  (Benefits t - Costs t ) (1/1+ r)t (2)
The discount rate is r, and the discount factor is 1/(1 + r). If we let r = 5%, as
in the earlier example, then the discount factor is 1/1.05, which is less than one.
The letter t represents time, and benefitst-costst is simply net benefits in period t.
As it increases, the discount factor is raised to a larger and larger power, and,
because it is less than one, raising it to a higher power makes it ever smaller,
reducing the net present value. The symbol  tells us to sum together the net
benefit stream from time 0 to time T. In general, this process of valuing the future
less than the present is known as inter-temporal discounting.
41
Resource and Economy One of the biggest non-market decisions, we face today is how to deal with
global climate change.
Virtually, all economic analyses of climate change place a lower weight on future
costs and benefits than on present ones. These analyses look at different policy
scenarios. They compare the present costs and benefits with discounted future
costs and benefits to arrive at a net present value (NPV). NPV implies that future
generations have no particular right to any resources, and we have no obligation
to preserve any. If a resource will be sufficiently more valuable in the future than
in the present, it should be saved for the future.
Discount rates do make sense for individuals in the short run. For some small-
scale, short-term social projects, they may also make sense. However, justifications
for discounting the future on a large scale and over long-time horizons are
questionable. Inter-temporal distribution is the apportioning of resources across
different generations, across different people. Distribution is fundamentally different
from allocation, and, consequently, justice replaces efficiency as the relevant criterion
for policy when time periods become intergenerational.
In the neoclassical economics, the system of discounting is exponential. Hence the
cost-benefit analysis of a number of ecosystem conservation projects does not
seem profitable for taking up. Hence the discounting for environmental projects
should be hyperbolic rather than exponential.
For an event such as climate change impacts we need to use hyperbolic discounting
instead of exponential discounting. Evidence shows that we value present to the
near future but indifferent to a far future. Climate change models typically creating
complex models of future costs and benefits of climate change. They compare
these to the costs of mitigation measures in a cost-benefit analysis designed to
calculate net present value. Hyperbolic discounting makes the present investment
to prevent future loss worthwhile.
3.5 MARKETS, INTERNATIONALIZATION AND

ENVIRONMENT
Internationalization refers to the increasing importance of relations between nations:
international trade, international treaties, alliances, protocols, and so on. The basic
unit of community and policy remains the nation, even as relations among nations,
and among individuals in different nations, become increasingly necessary and
important.
The case for free trade, is based on the assumption that trade is voluntary. Both
parties to a voluntary exchange must be better off, in their own estimation, after
the trade than before. Otherwise, they would not have made the trade. Under
what conditions is this happy result likely to be the case? The most obvious
condition is that of absolute advantage in cost differences reflected in the following
example. If country A can produce something at a lower absolute cost than
country B, while B can likewise produce something else at a lower absolute cost
than A , then there is a reason for voluntary exchange, assuming A wants some
of B’s product and B wants some of A’s product in the first place. This is the
condition of absolute advantage. A country has an absolute advantage good in
question at a lower absolute cost than its trading partner.
42
It has a comparative advantage if it can produce the good in question more Market, Trade and
Environment
cheaply relative to other goods it produces than can its trading partners, regardless
of absolute costs. The principle of comparative advantage is often illustrated with
the comparative advantage at work. Suppose a lawyer is a better typist than his
secretary. Should he fire her and do the typing himself? She would not do so
because, the opportunity cost of one hour which the lawyer devoted to practicing
law will fetch her more than one hour of typing. Her opportunity cost is higher.
Secretary’s opportunity cost is lower. The same principle is applied to the nations.
We suppose that labour is the only input in the production of any commodity.
Suppose one year of labour input by United States of America can produce 50
Television sets and 50 computers. Suppose one year of labour input by Japan
produces 10 computers and 40 television sets. It is clear that for the same amount
of labour, USA is able produce more of both television sets and computers.
Hence USA has an absolute advantage over Japan in producing both the goods.
All the same, it is worthwhile for USA to specialize and trade with Japan. USA
has comparative advantage in Computers and Japan has comparative advantage
in Television sets.
The theory of comparative advantage says that trade can be beneficial to both the
countries even if one country has an absolute advantage in producing both the
goods, provided the other country has a comparative advantage. Consider a
world in which we have two countries, A and B, each producing two goods, coal
(C) and wheat (W). The comparative or relative cost of W to C in country “A”
can be calculated and compared to the comparative or relative cost of W to C
in country “B”. That information will be sufficient to demonstrate the possibility of
mutual gains from trade between A and B. The argument will depend only on
comparative advantage (internal cost ratios), and not on cross country comparisons
of cost (absolute advantage).
A has total resources of 2a. With unit costs of both coal and wheat equal to 1a,
it can produce one unit of coal and one unit of wheat with its endowment of 2a
resources. Country B has a total resource endowment of 5b. B allocates 4b
resources to produce one unit of wheat, and with the 1b remaining can produce
one unit of coal. Total world output before trade is 2W + 2C.
Now let each country specialize in the production of the commodity in which it
has a comparative advantage and trade for the other commodity. A will specialize
in wheat, allocating all of its 2a resources to wheat, and with a unit cost of wheat
of 1a will end up producing 2W. B will allocate all 5b units of its resources to
production of coal, and with a unit cost of coal of 1b will produce 5C. Total
world product after specialization and trade is 2W + 5C. The world has gained
an extra 3C with no extra resources. The world is better off.
However, international trade does not take into consideration the externalities of
excess coal production in one country and the externalities of transport costs
which are energy intensive. Free trade, specialization increases the interdependence.
Thus the actual gain from comparative advantage will be reduced if we internalize
the externalities. The basic theory of Comparative advantage assumes that capital
and labour are immobile and only the commodities are exchanged. However in
the current scenario of capital movement, if capital were mobile internationally, it
is obvious that capitalists would seek the greatest absolute profit and consequently
the lowest absolute cost of production.
43
Resource and Economy In our example, if capital were mobile and the capitalists knew that 1a = 5b, so
that B had an absolute advantage in both coal and wheat, they would invest in
country ‘B’ and forget about A. Comparative advantage would be irrelevant. If
capital is mobile, absolute advantage is the relevant criterion. The only reason the
capitalist would ever be interested in comparative advantage is if capital were
immobile internationally. If capital cannot follow absolute advantage abroad, then
the next best thing is to follow comparative advantage specialization at home and
trade for the foreign product. Comparative advantage is a clever second-best
adaptation to the constraint of international capital immobility. But without that
constraint, it has no reason to be, and absolute advantage is all that counts. What
are the advantages of an internationalized economic system over a globalized
one? One is that nation-states that can control their own boundaries are better
able to set their own monetary and fiscal policy, as well as such things as
environmental standards and a minimum wage. Markets hate boundaries, but
policy requires boundaries.
1. What is Inter-temporal Allocation?
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2. What is Inter-temporal discounting?
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3.6 MARKETS, GLOBALIZATION AND

ENVIRONMENTAL DEGRADATION
Globalization is entirely different from internationalization. Under globalization, all
national economies are integrated into one global economy and must obey the
laws laid down by global economic institutions. Currently, the WTO is such an
organization. Under internationalization, relations between countries grow
increasingly important, but the nation remains the basic unit of community and
policy.
Globalization refers to global economic integration of many formerly national
economies into one global economy, by free trade, especially by free capital
mobility, and also, as a distant but increasingly important third, by easy or
uncontrolled migration. Globalization is the effective erasure of national boundaries
44 for economic purposes. National boundaries become totally porous with respect
to goods and capital, and increasingly porous with respect to people, viewed in Market, Trade and
Environment
this context as cheap labor, or in some cases cheap human capital. The classical
economists who argued for free trade based on comparative advantage were
basically nationalists and retained their fundamental commitment to the nation even
as they advocated internationalization.
Principles of conservation under International trade and globalization
The diagram below (fig. 3.4) illustrates the marginal costs and benefits of
deforestation at different spatial levels. Curve MNPB shows the marginal net
private benefits of deforestation to the farmers on the Atherton Tablelands of
Australia. This curve accounts for the cost of lost ecosystem services that directly
benefit the farmer. It slopes downwards as the benefits start declining with more
deforestation. The adverse impact will be experienced with a lag when the farmers
suffer the adverse impact through lower yields. Through ignorance, farmers initially
cleared amount OB of forest, till the marginal benefit became zero. If they had
they been better informed, they would have cleared amount OA.
Towns downstream of deforested farmlands suffer from irregular water flow and
poor quality. The nature tourism industry in the region generates far more income
than farming, and it also suffers from deforestation. These local marginal external
costs of deforestation (MEC local) are also depicted on the graph. If the local
governments had been aware of these negative externalities, they might have
implemented policies designed to limit deforestation to point C.
Similarly, the marginal external costs of national and international society are also
shown in the graph as marginal external costs of deforestation are shown for local,
national, and international society, along with the corresponding optimal levels of
deforestation: C, D, and E, respectively. The international cost also includes the
local cost. If there had been sufficient information, lack of ignorance on the issues
of deforestation and mechanisms to transmit the benefits of not cutting the forest
to the local level from the international level the deforestation would be at the level
of E.
Fig. 3.4: Marginal External Cost of Deforestation 45

Resource and Economy Trade and Pollution Haven Hypothesis
The world economy in the last decade has been characterized by liberalization of
trade, which question consequences on the world environment. The debate on the
effects of international trade on environmental quality began with the negotiations
over the North American Free Trade Agreement (NAFTA), the Uruguay round
of the General Agreement on Tariffs and Trade (GATT) negotiations, and the
formation of the World Trade Organization (WTO). This debate gained much
importance due to the Kyoto and Montreal Protocols and discussions on the
impact of Green House Gas emissions on global warming and climate change.
Recently, there has been a large amount of economic literature on the adverse
impacts of trade in making the developing countries the home of polluting industries.
There are two competing hypotheses that predict how international trade affects
the environment.
The Pollution Haven Hypothesis (PHH) predicts that, under free trade, multinational
firms will relocate the production of their pollution-intensive goods to developing
countries, taking advantage of the low environment monitoring in the developing
countries. Over time, developing countries will develop a comparative advantage
in polluting industries and become “havens” for the world’s polluting industries.
Thus developed countries are expected to benefit in terms of environmental quality
from trade, while developing countries will see their environmental quality
deteriorating. There were many case studies that have shown that the developing
countries increase their economic growth by exporting the goods of polluting
industries. However, some would argue that it is not the environmental regulation
of the developed countries but due to the comparative advantage of the developing
countries in producing them (Temurshoev, 2006).
The Factor Endowment Hypothesis (FEH), on the contrary, asserts that it is not
the differences in pollution policy, but the differences in endowments or technology
that determine trade. In particular, it predicts that the capital abundant country
exports the capital-intensive (dirty) goods, which stimulates its production, thus
raising pollution in the capital abundant country. Conversely, pollution falls in the
capital-scarce country as a result of contraction of the production of pollution-
intensive goods, since there is no comparative advantage of producing polluting
goods in the developing world. So overall, the effects of trade on the environment
both locally and globally depend on the distribution of comparative advantages
across countries. It is important to note that comparative advantage is determined
jointly by differences in pollution policy and among other influences by differences
in factor endowments. There were studies that support this hypothesis.
However, there was no conclusive proof that is universally true for both the
hypotheses. For example, both the US and China are historically the largest
emitters of the carbon dioxide (CO2), which is the most prominent greenhouse
gas (76%) in the earth’s atmosphere. According to International Energy Agency
(IEA) data, in 1997 the US and China were responsible for 24% and 14% of
the total world CO2 emissions from fuel combustion, respectively. A study has
examined the two theories in respect of these two countries and the study concludes
that there is no conclusive proof for either of these theories. It only shows that
trade have an impact on pollution increase, though it depends upon the type of
goods exchanged.
46
Check Your Progress 2 Market, Trade and
Environment
1. What is Pollution Haven Hypothesis?
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2. What is Factor Endowment Hypothesis?
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3.7 LET US SUM UP

l A market is a system in which buyers and sellers of something (commodity
or service) interact. Market participants, as both buyers and sellers, can be
individuals, firms and governments. Markets function efficiently only when
the market price reflects the true cost.
l Globalization is entirely different from internationalization. Under globalization,
all national economies are integrated into one global economy and must obey
the laws laid down by global economic institutions. Currently, the WTO is
such an organization. Under internationalization, relations between countries
grow increasingly important, but the nation remains the basic unit of community
and policy.
l The concept of comparative advantage is largely irrelevant in a world of
mobile financial capital. We must instead look at absolute advantage. While
absolute advantage is likely to lead to greater overall gains, it will also
produce both winners and losers on an international level. Without the elegant
theoretical conclusion of comparative advantage that free trade is a win-win
affair for all countries, it is necessary that we look at the empirical evidence
regarding each country’s absolute advantage to determine winners and losers
under a regime of global integration. There has been a large amount of
economic literature on the adverse impacts of trade in making the developing
countries the home of polluting industries.
3.8 KEY WORDS

Globalization: The economic integration of the globe by free trade, free capital
mobility, and to a lesser extent by easy migration. It is the effective erasure of
national boundaries for economic purposes.
Internationalization: The increasing importance of relations among nations, and
among citizens of different nations. The nation remains the basic unit of community
and policy, controlling to some extent trade, capital flows, and migration. National
economies are interdependent, but not integrated.
47
3.9 REFERENCES AND SUGGESTED FURTHER
READINGS
l Baumol, W.J. and Blinder, A.S. 1994. Economics: Principles and Policy. The
Dryden Press, Harcourt Brace & Company, Fort Worth. Pp. 999.
applications. Island Press, Washington. pp 454.
University Press, 198, Madison Avenue, New York-10016. Pp.470.
l Temurshoev, U. 2006. Pollution Haven Hypothesis or factor endowment
hypothesis: Theory and empirical examination for USA and China. Charles
University, Center for Economic Research and Graduate Education, Academy
of Sciences of the Czech Republic, Economics Institute working paper 292.

l The apportionment of resources across different stages in the lifetimes
of basically the same set of people (same generation).
l The process of systematically weighting future costs and benefits as less
valuable than present ones.
l The Pollution Haven Hypothesis (PHH) predicts that, under free trade,
multinational firms will relocate the production of their pollution-intensive
goods to developing countries, taking advantage of the low environment
monitoring in the developing countries.
l Developing countries over time will develop a comparative advantage
in polluting industries and become “havens” for the world’s polluting
industries.
l Developed countries are expected to benefit in terms of environmental
quality from trade, while developing countries will see their environmental
quality deteriorating.
l The Factor Endowment Hypothesis (FEH) asserts that it is not the
differences in pollution policy, but the differences in endowments or
technology that determine trade.
l It predicts that the capital abundant country exports the capital-intensive
(dirty) goods, which stimulates its production, thus raising pollution in
the capital abundant country.
48
UNIT 4 ECONOMIC ACTIVITY:
IMPACTS
Structure
4.0 Introduction
4.1 Objectives
4.2 Co-evolutionary Economics
4.3 Carrying Capacity, Population Dynamics and Extinction
4.4 Carrying Capacity of the Human Population and the Ecological Footprint
4.5 Concept of Overshoot and Dangers of Collapse
4.6 Impact of Economic Activity on Climate Change
4.7 Impact of Climate Change in the Context of India
4.7.1 India’s GHG Emission Profile
4.7.2 Impact of Climate Change
4.8 Let Us Sum Up

4.9 Key Words
4.0 INTRODUCTION
Ecological economists look at the Earth as a ship and gross material production
of the economy as the cargo. The seaworthiness of the ship, the earth, depends
upon its ecological health. The abundance of its provisions and its design are all
part of its healthy state. “Ecological economists recognize that we are navigating
unknown seas and no one can predict the weather for the voyage, so we don’t
know exactly how heavy a load is safe.” We only know that too heavy a load
will cause the ship to sink. In our anxiety to ensure that the ship is not already
over loaded, we want to make sure how much cargo each of the passengers have
loaded – the contribution of nations to the ecological footprint.
Humans over exploit the earth’s resources through the long journey of the human
race from hunter- gatherers, centuries ago to an energy dependent society of
today that made humans virtual slaves of energy. It is important to measure how
much of the earth’s space is used up for the economic activity and the wastes
generated. This is the ecological footprint. If the space required for human demands
is compared with the capacity of earth to provide us the renewable resources and
absorb waste, i.e. the bio-capacity, we will realize that the demand has already
exceeded the bio-capacity. The same situation of overshoot can also be shown
by the IS-LM model adopted to include the limits of bio-capacity. While it is not
possible to be accurate in the assessments of the impacts and the measurement
of the space used up by economic activity, or the extent of the actual overshoot,
efforts by ecological economists in this direction will help us to be aware and
beware of the threats of disasters looming large. Climate change and biodiversity
loss are such threats. Again, conservation of biodiversity as well as mitigation of
climate change impact entail costs and need application of basic economic principles. 49
4.1 OBJECTIVES
l state the concepts of carrying capacity, population dynamics and overshoot;
l underline the impact of economic activity on climate change; and
l explain the impact of climate change in Indian context.
4.2 CO-EVOLUTIONARY ECONOMICS

Co-evolutionary economics is the study of the mutual adaptations of economy
and environment. Economic activity induces changes in the environment, and
changes in the environment in turn induce further changes in the economy in a
continuing process of co-evolution. Economic system is embedded as a component
of human culture, and like our culture, it is in a constant state of evolution (Polanyi,
2001). In fact, our ability to adapt to changing environmental circumstances through
cultural evolution is something that most clearly distinguishes humans from other
animals. Economic, social, and political systems, as well as technological advances,
are examples of adaptations. All these systems were adapted in response to
changes in the environment and these adaptations in turn provoke subsequent
environmental change, to which we must again adapt in a co-evolutionary process.
Hunter – Gatherers to Energy slaves
The entire change in the human evolution, from hunter-gatherer stage to agricultural
settlements, property rights, irrigation, technology, natural resource exploitation is
an example of co-evolution of humans with environment. Gradually, hunter-gatherer
societies developed the technology to store large quantities of food for months on
end, an essential precursor to agriculture. Agriculture ended the nomadic lifestyle.
People began to settle in villages and towns or small communities, which led to
greater population concentrations than had previously been possible. Irrigation
over time led to increased soil salinity- eventually reducing the capacity of the
ecosystem to sustain such high population levels without further agricultural
innovations or migration. Agricultural technologies that boosted production were
a response to overcome this limitation.
Industrial revolution, international trade and global economic integration also have
their share of natural capital depletion - of especially non-renewable resources.
At every stage of economic evolution using natural resources, there is an
accompanying impact of environmental change, over exploitation of natural
resources and biodiversity loss. For the first time, human society became largely
dependent on fossil fuels and other non-renewable resources (partially in response
to the depletion of forests as fuel). Fossil fuels allowed the replacement of both
human and animal labor by chemical energy. This increased energy allowed us
greater access to other raw materials as well, both biological and mineral and their
greater exploitation. Energy use started with the use of coal during Industrial
revolution and oil became dominant in the middle of nineteenth century.
The human energy equivalent is a unit of measurement, which is the amount of
somatic energy required by an individual human being. One human energy equivalent
is the amount of energy flowing through a human body. The energy use increased
century after century from that of one human energy equivalent in the hunter-
50
gatherer stage to 93 in 1997 in USA. It was about 20 for the world as a whole. Economic Activity – Impacts
It was low in the countries with lower standards of living. In other words, it is like
having 20 human slaves (Energy Slaves) working for one person. It means that
there are twenty times more humans in the world extracting world’s resources and
putting pressure on the natural resources and waste absorption capacity. Once we
mastered energy and now the excess use of energy is mastering the destiny of
human future. Emissions exceeded the earth’s capacity to absorb the carbon
dioxide. It increased the concentration of carbon dioxide in the atmosphere
bringing about the green house gas effect of increase in temperatures and global
warming, destruction of ozone layer and adverse impacts of climate change,
which we shall study in the subsequent section.
International trade exploded, linking countries together as never before. A greater
ability to meet basic needs, and advances in hygiene and medical science, resulted
in dramatic increases in population, whose needs were met through greater energy
use and more rapid depletion of resources. Per capita consumption soared, and
with it, the waste output that now threatens to degrade our ecosystems. The
success of the Industrial Revolution dramatically reduced the scarcity of consumer
goods for much of the world’s population. The accompanying economic growth,
however, now threatens the former abundance of the goods and services produced
by Nature, upon which, we ultimately depend.
It is this concept of co-evolutionary economics that induced the ecological
economists and environmental economists to use joint production techniques to
evaluate the costs and benefits of an industry. Joint production means that the
manufacture of a good – the main product is necessarily accompanied by production
of by-products including the production of solid, liquid and gaseous polluting
wastes. If an industry produces unwanted by-products that are detrimental to the
society, then the disposal of unwanted production increases the cost of production
of wanted products. Joint production technique estimates the total cost of the
product including the costs of wastes disposal as well as damage done. It makes
sure that ecological evaluation impacts economic evaluation.
4.3 CARRYING CAPACITY, POPULATION

DYNAMICS AND EXTINCTION
The biotic components of an ecosystem are plants and animals. A population is
a group of individuals belonging to the same species, which live in a given area
at a given time. One way of looking at the ecosystem behavior over time is in
terms of the dynamics of populations that make the ecosystem. There are many
factors that determine the dynamics. These factors need more sophisticated models
backed by experiments. A very simple model is exponential growth, where the
proportional increase is the same in each time period, which means that the
absolute increase keeps on getting bigger over time. While an exponential annual
growth rate of 1% of a population takes 69.7 years to double, an annual rate of
growth of 5% takes only 14.2 years to double. A growth rate of 10 % takes 7.3
years for doubling. The type of population dynamics, where the growth rate falls
with increase in population is called the density dependent growth. Logistic growth
is a particular kind of a density dependent growth. In logistic growth, instead of
a fixed growth rate such as 5%, there is a growth rate that varies with the
difference between the size of the population and the carrying capacity of its
environment. The populations in nature have spiral population dynamic other than
51
Resource and Economy exponential and logistic ones that are density dependent. There are oscillating
movements in the size of the population with the diverging as well as converging
and constant amplitude that gives the size of the oscillation. Diverging oscillations
lead to collapse.
Stocks of plants and animals in nature cannot grow forever. The population’s
environment sets its upper limit to the size it can attain, because, there is an upper
limit to the solar radiation for plant population and available food for the animal
population. The maximum population size that the environment can support is
called the Carrying capacity. Ecologists have built several models with inter-
species competition for limited food as well. The question being asked often
about the time path of the population dynamics is whether they attain equilibrium.
The question of stability is about the time path returning back to the equilibrium,
if disturbed by an external shock. Ecologists point out three possible outcomes:
l First is the case, where there is no equilibrium in which both the species can
exist. One species out competes the other species. Hence one of the species
becomes extinct.
l Second is the case, where there is an equilibrium that is stable. Both the
species co-exist and from larger sizes that are not in equilibrium the size of
each is limited to the equilibrium size.
l Third, is the case in which an unstable equilibrium exists, with respect to each
population. It can be disturbed easily and one of the species becomes extinct,
if the equilibrium is disturbed.
The actual ecosystems as against the experimental ones built, show co-existence
of many species, which indicates that they are not competitive and food is probably
not the limiting factor. All the same survival of the fittest species and the extinction
of others lead to loss of biodiversity.
Loss of biodiversity – the nature of the problem
Biodiversity is the diversity of living organisms, the genes that they contain and the
ecosystem in which they exist. Populations are reproductively isolated sub-groups
of species. A species is taken as a unit of account. Biodiversity is lost when
species goes extinct. We do not know how many species exist. Nevertheless, we
know that there are many. About 1.75 million species have been actually identified.
The total number could be a 100 million or just 3.7 million. Tropical countries are
rich in bio-diversity. Extinction is a natural phenomenon. Yet rich biodiversity is
known to promote resilience in the ecosystem, after a shock or disturbance, man
made or natural. Extinction of a species is irreversible and lost forever. Some
non-domesticated species that are renewable are important for food and also may
have medicinal value. (Codfish is an example). Domesticated species are inputs
for agriculture. Their wild relatives give us the precious genetic material to cross
breed. Unknown genetic material if exists can be utilized as useful material through
research. If biodiversity is lost an opportunity is lost. The biodiversity is important
for better functioning of the ecosystem. When a species is extinct, it shows that
its environment has changed an ecosystem function that is vital for its existence
is lost. Resilience of the ecosystem will be threatened by the removal of the key
stone species. It appears that in any given ecosystem, there is subset of total suit
of species present that carries out the essential roles. Such species are called key
stone species. Their extinction indicates the loss of the ecosystem functioning.
52
Measure of Biodiversity loss – The Living Planet Index Economic Activity – Impacts
Using an expanded set of complementary indicators, the Living Planet index

documents the changing state of biodiversity to a small extent in respect of
vertebrates. Living Planet Index (LPI) reflects changes in the planet’s ecosystems
by tracking trends in nearly 8,000 populations of vertebrate species. Much as a
stock market index tracks the value of a set of shares over time as the sum of
its daily change, the LPI first calculates the annual rate of change for each species
population in the dataset. The index then calculates the average change across all
populations for each year from 1970, when data collection began, to 2007, the
latest year for which data is available. This Living Planet Index is based on trends
in 7,953 populations of 2,544 mammal, bird, reptile, amphibians and fish species.
The global Living Planet Index is the aggregate of two indices — the temperate
LPI (which includes polar species) and the tropical LPI — each of which is given
equal weight. The tropical index consists of terrestrial and freshwater species’
populations found in the afro-tropical, Indo-Pacific and Neo-tropical realms, as
well as marine species’ populations from the zone between the Tropics of Cancer
and Capricorn. The temperate index includes terrestrial and fresh water species’
populations from the Pale arctic and Nearctic realms, as well as marine species’
populations found in north or south of the tropics. In each of these two indices,
overall trends between terrestrial, freshwater and marine species’ populations are
given equal weight.
As per the eighth edition of the living Planet, in 2010, one of the longest-running
measures of the trends in the state of global biodiversity of vertebrates is the
Living Planet Index. A global decline of almost 30 per cent of the Biodiversity
between 1970 and 2007 is apparent from the successive reports. Trends regarding
tropical and temperate species’ populations are starkly divergent: the tropical LPI
has declined by 60 per cent while the temperate LPI has increased by almost 30
per cent. Loss of tropical biodiversity cannot be offset by increase in the biodiversity
of the temperate zone. It is because, the tropics are very rich in biodiversity and
their natural habitat needs to be preserved. The reason behind these contrasting
trends are likely reflects differences between the rates and timing of land-use
changes, and hence habitat loss. The increase in the temperate LPI since 1970
may be because it is starting from a lower baseline, and that species’ populations
are recovering following improvements in pollution control and waste management,
better air and water quality, an increase in forest cover, and/or greater conservation
efforts in at least some temperate regions.
Some contrasting regional trends in tropical zone, in the Afro-tropical realm and
Indo-Pacific realms are interesting to note. The Afro-tropical realm shows signs
of recovery since the mid-1990s when the index reached a low of -55% and
improved to by 37% to show a net decline of -18% since 1970. This increase
may partly be due to better protection of wildlife in nature reserves and national
parks in countries, such as Uganda. Indo-Pacific LPI that includes the Indo-
Malayan, Australasian and Oceanic realms has shown a decline of -66%. The
decline in the LPI reflects rapid agricultural, industrial and urban development
across the region, which has led to the most rapid destruction and fragmentation
of forests, wetlands and river systems anywhere in the world. Tropical forest
cover between 1990 and 2005, for example, declined more rapidly in Southeast
Asia than in Africa or Latin America, with estimates ranging from 0.6 % to 0.8 %
per year.
53
Resource and Economy Problems of Biodiversity Conservation
Loss of biodiversity is a difficult problem to solve. It is because in many respects
biodiversity is a global public good. Some species used directly in consumption
are rival in nature. The species that are not directly used are also useful as they
indirectly make the ecosystem function well. The genetic material is useful for
medicines and research. All these uses are non-excludable and non-rival in nature.
Conservation poses a problem because it entails costs. In-situ conservation is in
their natural habitat and ex-situ conservation is in the places constructed by
humans. All known endangered species cannot be conserved. Tropical countries
are rich in biodiversity. Nevertheless, most of these countries are poor and cannot
afford to bear the costs of in-situ conservation of protecting their natural habitat.
Further, economic cost - benefit analysis has to decide which species is the
candidate for conservation. Hence it depends upon the value that a society puts
on their preservation, depends upon how much they like it and how useful it is.
Since it is difficult to decide based on the nature of the species, the guiding
principle is conservation of biodiversity for biotechnology. The problem is that if
developing countries bear the cost of conservation, the developed countries get
the benefits of biotechnology and patent the uses and benefit. The actual conservers
of biodiversity of the poor tropical countries that entails costs of conservation may
benefit from ecosystem functions, but may not be able to benefit from the
commercial use. Thus biodiversity being a public good and being non-excludable
and non-rival has typical problems of not getting adequate funding and interest for
conservation.
4.4 CARRYING CAPACITY OF THE HUMAN

POPULATION AND THE ECOLOGICAL
FOOTPRINT
Having understood the carrying capacity of populations of species, we shall now
examine the carrying capacity of human beings on earth. Carrying capacity of the
humans is the size of the population that a given ecology can support. The main
factors that determine the carrying capacity are the levels of population, pattern
of resource demand, environmental yield potential and resource flows and
environmental waste absorption capacity, and impacts. It is the aggregate demand
of the population that will ultimately be limited by carrying capacity. Aggregate
demand may be computed as the average per capita demand in terms of
consumption emissions and waste production multiplied by the number of people.
If human demands approach the limits imposed by the carrying capacity of the
planet, it is likely that other environmental and related costs would start rising
steeply. The true maximum sustainable yield rates are not easy to calculate. We
need multi-species analysis along with the ecosystem changes that had taken
place. Necessary information is often not available. Carrying capacity can be
calculated for each region as well as for the whole world. Each country has a
carrying capacity. There are several estimates of the earth’s carrying capacity of
human population. For example, G. Daily, A. Ehrlich, and P. Ehrlich, argue that
5.5 billion people clearly exceed the planet’s carrying capacity and suggest optimal
populations of 1.5 to 2 billion. It is difficult however to accurately estimate.
The national and regional carrying capacities are totally obscured by the international
trade and capital movements. This has an effect of transferring the carrying capacity.
54 A flow of resources from a natural capital rich country to natural capital –poor
country, will allow the natural capital poor countries to live beyond their carrying Economic Activity – Impacts
capacity, with higher levels of consumption and higher levels of population beyond
the carrying capacity of their nations. Thus the national carrying capacities cannot
be achieved without over shooting the global carrying capacity. Under certain
circumstances, the transfer of carrying capacity would no longer be viable.
1. When it becomes impossible for the natural capital exporting country to
maintain outward flow of resources is not viable. This might happen when the
population growth occurs along with natural resource depletion, the export
margins turn negative and the country turns an importer.
2. If the maintenance of the flow of resources itself incurred high-energy costs
and such costs rise to a point where the operations become marginal, the
transfer becomes unviable. If extraction of natural resources as well as the
transport of resources is energy intensive and expensive, a continued transfer
of natural capital is not viable.
Global and Regional Ecological Footprints and trends
Concept: The Ecological Footprint is an accounting framework that tracks
humanity’s competing demands on the biosphere by comparing human demand
against the regenerative capacity of the planet. It does this by adding together the
areas required to provide renewable resources people use, the areas occupied by
infrastructure, and the areas required for absorbing waste. In the current National
Footprint Accounts, the resource inputs tracked include crops and fish for food
as well as other uses, timber, and grass used to feed livestock. CO2 is the only
waste product currently included. Since people consume resources from all over
the world, the Ecological Footprint of consumption, the measure reported here,
adds together these area. The footprint estimates area needed regardless of where
the area is located on the planet. The footprint is expressed in Global hectares.
Bio-capacity is the regenerative capacity of the planet earth. Bio-capacity is the
total regenerative capacity available to serve the human demand for resources.
Bio-capacity includes cropland for producing food, fiber and bio-fuels; grazing
land for animal products such as meat, milk, leather and wool; coastal and inland
fishing grounds; and forests, which both provide wood and absorb CO2. Bio-
capacity takes into account the area of land available, as well as the productivity
of the land, measured by how much the crops or trees growing on it yield per
hectare. Cropland in dry and/ or cold countries, for example, may be less productive
than cropland in warmer and/or wetter countries. If a nation’s land and sea are
highly productive, a country’s bio- capacity may include more global hectares
than it has actual hectares. Similarly, increases in crop yields will increase bio-
capacity. For example, the area of land used for growing the most prevalent
crops, cereals, has remained relatively constant since 1961, while the yield per
hectare has more than doubled.
Both the Ecological Footprint (which represents demand for resources) and bio-
capacity (which represents availability of resources) are expressed in units called
global hectares. One global hectare represents the productive capacity of 1hectare
of land at world average productivity.
The data and calculation: While the term ecological footprint is widely used, the
methods of measurement vary. However, calculation standards are now emerging
to make results more comparable and consistent. They are also becoming more
sophisticated and based on detailed input output tables of production and 55
Resource and Economy consumption national accounts. Now the methodologies used, recognize land
disturbance caused by various industrial categories and specific household level
consumptions of various layers. The first academic publication about the ecological
footprint was by William Rees in 1992. The ecological footprint concept and
calculation method was developed as the PhD dissertation of Mathis Wackernagel,
under Rees’supervision at the University of British Columbia in Vancouver, Canada,
from 1990–1994. Detailed India study published by the Confederation of Indian
Industries would be considered in the next block on Environmental issues in India.
Criticism of the Methodology and Some Improvements
Since the formulation of the ecological footprint, a number of researchers have
criticized the method of calculating as originally proposed. The criticisms largely
refer to the oversimplification in ecological footprints of the complex task of
measuring sustainability of consumption. It underestimates consumption of a single
population as well as the wastes generated. All solid, liquid and gaseous wastes
are not included. Only the carbon absorption capacity is considered. Thus the
footprint is gross underestimation. Further the bio-capacity is also over estimated,
as all demands on earth’s resources are not considered. Another problem is that
it does not tell us where the footprint had fallen and degradation had taken place.
The concept has been undergoing significant modifications that include use of
input-output analysis, renewable energy scenarios, land disturbance as a better
proxy for sustainability, and the use of production layer decomposition, structural
path analysis and multivariate regression in order to reveal rich footprint details.
Comprehensive input-output-based ecological footprints are now calculated in
many individual countries, and applied to populations, companies, cities, regions
and nations.
Trends in Global Ecological Footprint
The global ecological footprint is regularly calculated and published as Living
Planet Report by World Wide Fund with a three year lag due to the time it takes
for the United Nation to collect and publish all the underlying statistics. The latest
report published in 2010 refers to the situation in 2007. According to the Living
Planet Report, the overall, humanity’s Ecological Footprint has doubled since
1966. During the 1970s, humanity as a whole passed the point at which the
annual Ecological Footprint matched the Earth’s annual bio-capacity that is, the
Earth’s human population began consuming renewable resources faster than
ecosystems can regenerate them and releasing more CO2 than ecosystems can
absorb. This situation is called “ecological overshoot”. The latest Ecological
Footprint shows this trend is unabated. This growth in ecological overshoot is
largely attributable to the carbon footprint, which has increased 11-fold since
1961 and by just over one-third since 1998. In 2007, humanity’s Footprint was
18 billion global hectares or 2.7global hectares per person. However, the Earth’s
bio-capacity was only 11.9 billion global hectares or 1.8 global hectares per
person. This represents an ecological overshoot of 50 per cent. This means it
would take 1.5 years for the Earth to regenerate the renewable resources that
people used in 2007 and absorb CO2 waste. Put another way, people used the
equivalent of 1.5 planets in 2007 to support their activities.
Regional footprints: However, not everybody has an equal footprint and there
are enormous differences between countries, particularly those at different economic
levels and levels of development. Therefore, for the first time, the Living Planet
56
Report looks at how the Ecological Footprint has changed over time in different Economic Activity – Impacts
political regions, both in magnitude and relative contribution of each footprint
component.
Examining the Ecological Footprint at the per-person level shows that people
living in different countries differ greatly in their demand on the Earth’s ecosystems.
For example, if everyone in the world lived like an average resident of the United
States or the United Arab Emirates, then a bio-capacity equivalent to more than
4.5 Earths would be required to keep up with humanity’s consumption and CO2
emissions. Conversely, if everyone lived like the average resident of India, humanity
would be using less than half the planet’s bio-capacity.
The Ecological Footprint according to four political groupings which broadly
represent different economic levels, illustrates that higher income, more developed
countries generally make higher demands on the Earth’s ecosystems than poorer,
less developed countries. In 2007, the 31 OECD countries which include the
world’s richest economies accounted for 37 per cent of humanity’s Ecological
Footprint. In contrast, the 10 ASEAN countries and 53 African Union countries
that include some of the world’s poorest and least developed countries together
accounted for only 12 per cent of the global footprint. As well as reflecting the
amount of goods and services consumed and CO2 waste generated by the average
resident, Ecological Footprint is also a function of population. The average per-
person Ecological Footprint is much smaller in BRIC countries ( Brazil, Russia,
India and China) than in OECD countries; however, as there are over twice as
many people living in BRIC countries as in OECD countries, their total Ecological
Footprint approaches that of OECD countries. The current higher rate of growth
in the per person Footprint of BRIC countries means these four countries have
the potential to overtake the 31 OECD countries in their total consumption.
1. What is Co-evolutionary Economics?
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2. What do you mean by Ecological Footprint?
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4.5 CONCEPT OF OVERSHOOT AND
DANGERS OF COLLAPSE
How can humanity be using the capacity of 1.5 Earths, when there is only one
earth? Just as it is easy to withdraw more money from a bank account than the
interest this money earns. Over shoot is like an overdraft. If you spend more than
what you earn by way of interest, you may have to live on over draft on the
principal amount in the bank for some time, becoming poorer and poorer by the
year and at some point, you will be a pauper, when the principal is spent.
Similarly at current consumption rates, these resources will eventually run out too
and some ecosystems will collapse. It is possible to harvest renewable resources
faster than they are being generated. More wood can be taken from a forest each
year than re-grows, and more fish can be harvested than are replenished each
year. However, doing so is only possible for a limited time, as the resource will
eventually be depleted. Similarly, CO2 emissions can exceed the rate at which
forests and other ecosystems are able to absorb them, meaning additional Earths
would be required to fully sequester these emissions.
Exhaustion of natural resources has already happened locally in some places, for
example the collapse of cod stocks in Newfoundland in the 1980s. At present,
people are often able to shift their sourcing when this happens, moving to a new
fishing ground or forest, clearing new land for farming, or targeting a different
population or a still-common species. Nevertheless, at current consumption rates,
these resources will eventually run out too and some ecosystems will collapse
even before the resource is completely gone. The consequences of excess
greenhouse gases that cannot be absorbed by vegetation are also being seen:
increasing concentrations of CO2 in the atmosphere, leading to increasing global
temperatures and climate change, and ocean acidification. These place additional
stresses on biodiversity and ecosystems.
Adapting IS-LM Model to explain Ecological over shoot
The concept of overshoot can also be expressed in standard neoclassical terminology
adopted to include ecological concerns. The basic IS-LM model was developed
by the economist John Hicks of oxford University to explain the Keynesian
theory. The IS-LM model is a two-sector general equilibrium model, the sectors
being the real sector (goods and services sector) and the monetary sector (demand
for and supply of money). Hicks showed that the real and monetary sectors
simultaneously interact to determine both the interest rate and national income.
This is a simplified version of the entire economy, where the LM curve shows the
money market equilibrium and the IS curve shows the goods and services market
equilibrium.
National income is synonymous to the value of output as the total value of output
is paid to the owners of the factors of productions as factor income. When the
economy is in equilibrium, when all the expenditure on goods and services in the
economy is equal to the income paid out to the people as factor payments, the
savings are equal to Investment. ‘Y’ represents both total expenditure as well as
total national Income. Income is equal to consumption plus savings. Total
expenditure is equal to consumption (expenditure) and investment (expenditure).
At equilibrium, when income is equal to the expenditure I = S is the condition of
equilibrium, when the Macro economic activity is stable.
Y (Income) = Consumption + savings
Y (Total Expenditure ) = Consumption + Investment
58 When Income = Expenditure then, Investment (I) = Savings (S).
The IS Curve: The IS curve shows the relationship between the National Income Economic Activity – Impacts
and the Interest Rates. Various points on the IS curve show the points of equilibrium
for various levels of National Income. It is easy to derive the IS curve, from the
investment function and the Keynesian condition of equilibrium. The investment in
the economy declines as the interest rates go up. It is because all those enterprises,
which gives a return lower than the prevailing interest rates, will not be undertaken.
It is because one might as well put the money in the bank and get the interest
instead of investing in an enterprise. Increase in investment however leads to
economic activity that generates a higher level of national income through multiplier
effect. Thus when interest rates fall, investment falls and the equilibrium level of
national income would be lower. Hence IS curve will be negatively related to
interest rates. It is a curve with a negative slope when depicted as a relationship
between interest rates and the level of equilibrium national Income.
The LM curve: In the money market, money supply (M) is taken as being
exogenously determined. The general price level is assumed to be fixed. It does
not depend upon the interest rate. Transactional demand for money (Md) on the
other hand is positively related to the level of national income, meaning that
people demand more money, when their incomes are high. Speculative demand
for money is negatively related to interest rates. It means that the higher the rate
of interest, the higher is the opportunity cost of “being liquid”; i.e., holding cash
as opposed to yield-bearing securities. Thus demand for money or the level of
liquidity is a function y and r.
L(r, Y) = M
In other words, the demand curve for money is downward sloping curve that
intersects the supply curve at higher levels as the Y increases. In simple terms,
an L=M or LM curve describes the points of equilibrium of demand for money
and supply of money for a different levels of Y. Given the unchanged money
supply, if the Income increases the demand for money increases and hence the
interest rates go up. Hence the LM curve is an upward sloping curve that shows
money market equilibrium at a given level of national Income.
IS-LM Model: Putting the IS and LM curves together we can determine a unique
combination of r and Y (namely r*, Y*) that satisfies both the S = I condition of
the real sector and the L = M condition of the monetary sector. The IS-LM
model is used in a comparative statics way to analyze the effect on r and Y of
changes in the underlying determinants. The underlying determinants are factors
such as propensity to save, efficiency of capital investment, and liquidity preference
and so on. Comparative statics is the analysis of what happens to endogenous
variables such as interest rates and national income in a model as a result of the
change in exogenous parameters. It compares the new equilibrium variables with
the old ones, without explaining the precise dynamic path leading from the old to
the new equilibrium.
Fig. 4.1: The IS-LM Model for Ecological Overshoot 59

Resource and Economy Thus, the IS-LM model treats all economic growth as identical — it does not
distinguish between government expenditures on market goods, man-made public
goods, or investments in ecological restoration, nor does it address distribution.
It also does not consider the lags in reaction and adjustments in reaching the
equilibrium. The original model uses full employment level of the economy as the
limiting factor to economic growth i.e. increases in Y.
Herman Daly has adopted the model to explain overshoot using the bio-capacity
of the nation as the limiting factor. We could assume a fixed throughput intensity
per dollar of Y (i.e., GNP), so that a given Y in money terms implies a given
physical throughput. Then we could estimate the maximum ecologically sustainable
throughput, converts that into the equivalent Y, and imposes that as an exogenous
constraint on the model, similar to the full employment level of Income. This is
represented by the vertical line in the diagram. Ecological overshoot occurs when
the IS-LM equilibrium pushes the level of Y (GDP) beyond the vertical line
representing the ecological limit of the economy as in the diagram II given above.
Then the government has to use fiscal measures such as taxation on polluting
production, and the IS curve inwards to coincide with the ecological capacity
given by the vertical line EC*. Expenditure on non-market goods such as
conservation measures helps to increase bio capacity and shift the EC curve right
words.
4.6 IMPACT OF ECONOMIC ACTIVITY ON

CLIMATE CHANGE
As per the latest living planet Report the carbon footprint, the growth in ecological
overshoot is largely attributable to the carbon footprint, which has increased 11-
fold since 1961 and by just over one-third since the publication of the first Living
Planet Report in 1998. However, not everybody has an equal footprint and there
are enormous differences between the countries, particularly those at different
economic levels and levels of development.
There is now an almost unanimous agreement among the climatologists that the
emissions of green house gases in particular of carbon dioxide contribute in an
essential way, to the change of global climate. CO2 emissions contribute 60% to
the effect of anthropogenic green house gases. Atmospheric CO2 concentration
has been steadily rising. Parallel to that the average global temperature has risen.
The climate change problem is different from other problems of environmental
pollution and degradation.
1. The intensity of the problem is determined by our present and future emissions
that arise from the production of energy from fossil fuels.
2. Measures for reduction of predicted effects are anticipatory.
3. There are no technologies that reduce the existing stocks of CO2 concentration
in the atmosphere.
4. We are not in a position to stop CO2 emissions on a global scale, any time
soon.
In contrast to the impacts of other pollution problems, which could be point
pollution or non-point pollution, economic analysis of climate change is relatively
straight forward. It is because bulk of the CO2 emissions result from burning fossil
60
fuels viz., Coal, Oil and Gas. Developed countries keep detailed records of these Economic Activity – Impacts
fuels through out the economy. Unlike the other polluting agents, the CO2 emission
impact is on atmospheric CO2 concentration.
Anthropogenic green house gas emissions and economic activity represented by
Gross Domestic Product are related. Energy use by the world grew significantly
faster, between 1950- and 1973. After the first oil shock in 1973, the USA’s
energy demand remained steady and that of European Union slightly declined. It
indicates energy use efficiency. The temporal pattern of energy use and the pattern
of emission of CO2 are similar. If we see the relationship between CO2 (C) and
GDP (Y) and Energy use (E) and GDP, we find that Energy/GDP and CO2/ GDP
or ratios are falling for the world, USA as well as EU.
Variables influencing the CO2 Emissions
It is well known that CO2 generation is higher for coal and oil and less for natural
gas. Thus substitution of coal and oil by gas reduces the emissions. In addition,
different industries emit different levels of CO2, since efficiency of fuel use differs.
Same amount of commodity can be produced with less energy with better
technologies. Some advanced technologies require less energy and emit less of
CO2. The factors that influence the CO2 emissions are division of energy use
between coal, oil and gas. More energy is used for heating and transport and less
is used for communications. The technical efficiency of energy use is also important.
The size of the population also determines the energy demand. An economic
model of CO2 emissions takes all these factors into consideration. There are three
important economic factors
1. The ratio of CO2 emissions to the total energy use in the economy C/E ratio
may change with the mix of the fuel use given the E/Y and Y remain unchanged
2. The ratio of energy use to GDP E/Y is important. A reduction in E/Y for the
same C/E and Y shows that the economy is more efficient in energy use.
3. The size of the GDP (Y) is important. Given an unchanged C/E and E/Y,
higher the Y larger will be the CO2 emissions
   
C/ C = (C/E)/ C/E + (E/Y)/ E/Y) + Y/Y
The above equation decomposes the rate of change in CO2 emissions into the
rate of change in emissions energy ratio and the rate of change in energy use GDP
ration the rate of change in GDP. It helps us to track the CO2 emissions over time.
This decomposition can be applied to sectors as well as nations. The policy
implications would be to change the structure of the fuel demand towards lower
CO2 emissions, Improving the energy efficiency and change over from fossil to
non fossil fuels.
4.7 IMPACT OF CLIMATE CHANGE IN THE

CONTEXT OF INDIA
Fact-based perspective on climate change in India has been developed by five
agencies independently using different models. Three of them were funded by the
government of India and the others were funded by other agencies. The findings
are presented in the web site of the ministry of environment and forests. The
details of five studies are as follows:
61
Resource and Economy 1. A computable general equilibrium (CGE) model study by India’s National
Council of Applied Economic Research (NCAER)
2. A Market Allocation (MARKAL) model study by The Energy & Resources
Institute (TERI)
3. An Activity Analysis model study by the Integrated Research and Action for
Development (IRADe)
4. Another MARKAL model based study by The Energy & Resources Institute
presented at the 14th Conference of Parties (COP) on Climate Change at
Poznan
5. A detailed sector-by-sector analysis of GHG emissions by McKinsey and
Company
4.7.1 India’s GHG Emission Profile

The studies mentioned above have differences in model structure, specific model
assumptions and parameters, as well as some differences in the definitions of the
illustrative scenarios. However, the results of all studies relate to India’s emissions
profile over the next two decades. The results estimate India’s GHG Emissions.
Estimates of India’s per capita GHG emissions in 2030-31 vary from 2.77 tonnes
to 5.00 tonnes of CO2 equivalent with four of the five studies estimating that
India’s GHG emission per capita will stay under 4 tonnes per capita. This may
be compared to the 2005 global average per capita GHG emissions of 4.22
tonnes of CO2 equivalent per capita. In other words, four out of the five studies
project that even two decades from now, India’s per capita GHG emissions
would be well below the global average 25 years earlier. In absolute terms,
estimates of India’s GHG emissions in 2031 vary from 4.0 billion tonnes to 7.3
billion tonnes of CO2 equivalent, with four of the five studies estimating that even
two decades from now, India’s total GHG emissions will remain under 6 billion
tonnes of CO2 equivalent. McKinsey study estimates include CH4 emissions from
agriculture, not taken into account in the other models. All studies show evidence
of a substantial and continuous decline in India’s energy intensity of GDP and CO2
intensity of GDP.
4.7.2 Impact of Climate Change

Impact has been assessed on India at the level of six geographical regions in
respect of various aspects such as mean temperature, rainfall, melting of ice, sea
level rise, cyclones, and productivities of crops and so on. All the changes in the
2030s are with respect to the average of the period 1961 to 1990s, also referred
to as the baseline.
Temperature: The annual mean surface air temperature is projected to rise by
1.7°C and 2.0°C in 2030s. Seasons may be warmer by around 2.0°C towards
the 2030s. Day and night temperature rise varies across the regions. Nights are
warmer in the southern peninsular India and day temperatures will be higher in the
northern region.
Precipitation: All the regions under consideration show a small increase in
annual precipitation in the 2030’s with respect to the baseline, that is 1970s. The
Indian Himalayan Region is projected to have an increase of 5 to 13% in rainfall.
The northeast region is to experience an increase between 0.3 to 3% in its rainfall.
62
The Western Ghats is expected to have an increase of 6 to 8 percent in the Economic Activity – Impacts
rainfall. The east coast is to have an increase of 0.2 to 4.4 percent in precipitation.
The west coast is to have an increase between 6 to 8 percent in rainfall compared
to base line of seventies. The frequency of rainy days will decline in many parts
of the country except the Himalayan region, in which they are likely to increase.
The intensity of rain (mm of rain per day) would increase.
Sea level rise: Because the ocean has an enormous thermal inertia, it takes many
decades for sea level to adjust to the quantity of heat that it absorbs. This delay
means that even if man-made GHG emissions were completely halted today, sea
level will continue to rise to the end of this century. Consistent and reliable data
available for India indicate that the sea level along the Indian coast has been rising
at the rate of about 1.3mm/year on an average. Globally, sea level is expected
to continue to rise over the next several decades at about the same magnitude.
The projected number of cyclonic disturbances along both the coasts in the 2030s
is estimated to decrease with respect to the 1970s. However, cyclonic systems
might be more intense in the future. Storm surge return periods could only be
estimated at a 100-year time scale. It is found that all locations along the eastern
coast of India, that are north of Visakhapatnam, except Sagar and Kolkata, show
an increase in 100-year return periods of storm surges by 15% to 20 % with
respect to the 1970s.
Water, Floods and Droughts: Water yield is projected to be higher by 5-50
% in the Himalayan region and Jammu and Kashmir and Uttarakhand, but it is
expected to be lower by about 20% in the North-Eastern region. The water yield
would be lower in the northern portion of the Western Ghats up to 50% but an
increase of about 10-20% in the central part of the Western Ghats. East coast
would a reduction by about 40% in the states, of West Bengal, Orissa and
northern Andhra Pradesh, but southern coast of Andhra Pradesh and Tamil Nadu
may have an improvement by about 40%. A 50% reduction in water yield is
expected for the west coast of India and a 10% reduction in Kerala and Karnataka.
Since drought depends upon the soil moisture retained, the Himalayan region is
expected to experience drought even with an increase in precipitation. Change in
peak discharge equal to or exceeding at 1% frequency in the 1970s and 2030s
for various regions indicates that the flooding increases from 10% to over 30%
of the existing magnitudes in most of the regions. This has a very severe implication
for existing infrastructure such as dams, bridges, roads, etc., in the areas and will
require appropriate adaptation measures to be taken up.
Crop, Livestock, and fisheries Productivity: Rice is expected to lose
productivity by about 4 to 20%; Maize and Sorghum could lose productivity
between 15-50% and coconut between 10-30%; Livestock productivity is likely
to decline in many parts of the country except in Himalayan region, in which it
would increase. Apple production would go down in the Himalayas and it may
shift to upper reaches. Livestock productivity is likely to be reduced in the coastal
regions. In the Himalayan region, the productivity may rise. Oil Sardines in the
Kerala coast may breed better in the monsoon season with increased temperatures.
Biomass Change: Biomass is expected to undergo substantial change in its
composition. Net primary production (NPP) is a measure of plant growth obtained
by calculating the amount of carbon absorbed and stored by plants. NPP is equal
to photosynthesis minus respiration. It is sometimes expressed in grams of carbon
produced per square meter per year. NPP is a major component of the carbon 63
Resource and Economy cycle. It is the net production of biomass. NPP is expected to increase in various
parts of the country between 20-57 percent in various parts of the country. The
largest increase is expected in the Himalayan region.
Human Health: A qualitative assessment indicates that morbidity and mortality
of the population in the regions under focus are likely to increase with warming
temperatures and variable precipitation as they have direct as well as indirect
effects. Direct effects can manifest as heat stress and indirect effects can be in
terms of vector borne diseases, water borne diseases and malnutrition, etc.
Thus, most of the impacts have an adverse economic aspect. The economic cost
of loss can be estimated. The assessment of risk and uncertainty is also in the
centre of the assessment of economic loss. Further, one has to take a long-term
view as well as a global view. It has been said that the economic loss and human
suffering will be more in the developing countries as people being poor do not
have the capacity to cope with the changes. No one can predict the consequences
of climate change with certainty but we understand the risks. Taking strong action
to reduce the emissions must be viewed as an investment, a cost incurred now
to avoid severe consequences in future. A study of the costs of climate change
and the costs and benefits of action taken to reduce emissions leads to the
conclusion that the benefits of strong and early action considerably outweigh the
costs. (Stern, 2006).
1. What are the problems of Biodiversity Conservation?
.................................................................................................................
.................................................................................................................
.................................................................................................................
.................................................................................................................
2. What are the potential impacts of Climate Change?
.................................................................................................................
.................................................................................................................
.................................................................................................................
.................................................................................................................
4.8 LET US SUM UP

l Co-evolutionary economics is the study of the mutual adaptations of economy
and environment. Economic activity induces changes in the environment, and
changes in the environment in turn induce further changes in the economy in
a continuing process of co-evolution. Economic system is embedded as a
component of human culture, and like our culture, it is in a constant state of
evolution.
l Biodiversity is the diversity of living organisms, the genes that they contain
64 and the ecosystem in which they exist. Living Planet Index (LPI) reflects
changes in the planet’s ecosystems by tracking trends in nearly 8,000 Economic Activity – Impacts
populations of vertebrate species. The Living Planet Index is based on trends
in 7,953 populations of 2,544 mammal, bird, reptile, amphibians and fish
species. The global Living Planet Index is the aggregate of two indices —
the temperate LPI (which includes polar species) and the tropical LPI —
each of which is given equal weight.
l Biodiversity is a global public good. Some species used directly in
consumption are rival in nature. The species that are not directly used are
also useful as they indirectly make the ecosystem function well. In many
ways, the loss of biodiversity is a difficult problem to solve.
l The Ecological Footprint is an accounting framework that tracks humanity’s
competing demands on the biosphere by comparing human demand against
the regenerative capacity of the planet. It does this by adding together the
areas required to provide renewable resources people use, the areas occupied
by infrastructure, and the areas required for absorbing waste. The footprint
estimates area needed regardless of where the area is located on the planet.
The footprint is expressed in Global hectares.
l Bio-capacity is the regenerative capacity of the planet earth. Bio-capacity is
the total regenerative capacity available to serve the human demand for
resources. Bio-capacity takes into account the area of land available, as well
as the productivity of the land, measured by how much the crops or trees
growing on it yield per hectare. One global hectare represents the productive
capacity of 1hectare of land at world average productivity.
l Despite under-estimation, the ecological footprint warns us of the dangers of
ecological over shoot, which can also be explained by an IS-LM model
adapted for this purpose.
4.9 KEY WORDS

IS-LM model: A two-sector general equilibrium model showing how the real
and the financial sectors interact to simultaneously determine the national income
and the interest rate.
4.10 REFERENCES AND SUGGESTED

FURTHER READINGS
l Common, M. and Stagl, S. 2005. Ecological Economics: An Introduction.
Cambridge University Press, Cambridge. pp 560.
l Costanza, R., Cumberland, J., Daly, H., Goodland, R. and Norgaard, R.
1997. An Introduction to Ecological Economics. St. Lucie Press and ISEE,
Florida. pp.274.
l Daly, H.E. and Farley, J. 2004. Ecological Economics: Principles and
applications. Island Press, Washington. pp 454.
University Press, 198, Madison Avenue, New York-10016. pp.470.
l Polanyi, K. 2001. The Great Transformation: the Political and Economic
Origins of our Time. Beacon Press, Boston. pp.360.
l Stern, N. 2006. The economics of Climate change: The Stern Review. 65
Resource and Economy Cambridge University Press, Cambridge. pp.712.
Websites:
www.zsl.org/indicators
www.livingplanetindex.org
www.footprintnetwork.org.
www.moef.gov.in

l Co-evolutionary economics is the study of the mutual adaptations
of economy and environment.
l Economic activity induces changes in the environment, and changes
in the environment in turn induce further changes in the economy in
a continuing process of co-evolution.
l Economic system is embedded as a component of human culture,
and like our culture, it is in a constant state of evolution.
l The Ecological Footprint is an accounting framework that tracks
humanity’s competing demands on the biosphere by comparing human
demand against the regenerative capacity of the planet.
l It does this by adding together the areas required to provide renewable
resources people use, the areas occupied by infrastructure, and the
areas required for absorbing waste.
l The footprint estimates area needed regardless of where the area is
located on the planet.
l The footprint is expressed in Global hectares.
l Biodiversity Conservation involves cost.
l Tropical countries are rich in Biodiversity. However, most of these
countries are poor and cannot afford to bear the costs of in-situ
conservation.
l Increase in temperature
l Sea Level rise
l Variability in precipitation
l Floods and Droughts
l Crop, Livestock and Fisheries productivity
66 l Human Health

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MSD-014

COURSE EDITOR COURSE COORDINATOR BLOCK COORDINATOR

Table 1.1: Classification of Resources with examples

Economics is the science of allocation of scarce resources and concerned with

The basic economic theories of renewable resources would be discussed in detail

l explain the basic concept of renewable and non-renewable resources;

l describe the economic theories of renewable and non-renewable resources;

l analyze the relationship between non-renewable resources and limits to

time interval t has elapsed. Bt is a stock concept as it represents the population

1.3 ECONOMICS OF FISHERY :

Fig. 1: Production Function of Fishery: The Sustainable Yield Curve

Source: Hussen (2000).

1.4 REGULATION OF FISHERY

1.5 LIMITATIONS OF STEADY-STATE BIO-

1.6 ECONOMIC THEORIES OF NON-

The above equation indicates that stock of non-renewable resources is depleted

However, it is impossible to have perfect recycling technology accruing to the

1.7 OPTIMAL ALLOCATION OF NON-

In real world situation, present use and consumption of non-renewable resources

l Non-renewable resources are fixed in supply. In reality, it is assumed that

l The persistent use of non-renewable stock resources will inevitably lead to

l Exhaustion of mineral resources is basically an economic event because

l The key point is how much of an exhaustible resource should be extracted

1.10 KEY WORDS

Non-Renewable resources: Those resources which are not replaceable, or

Recyclable non-renewable resources: These resources can be reused. These

1.11 REFERENCES AND SUGGESTED

l Daly, H.E. and Farley, J. 2004. Ecological Economics. Principles and

l Hussen, A. M. 2000. Principles of Environmental Economics: Economics,

l Kolstad, C.D. 2011. Intermediate Environmental Economics. Oxford

1.12 KEY TO CHECK YOUR PROGRESS

2.4 Natural Capital –Biotic Resources

2.5 Man-made Capital

After reading this unit, you will be able to:

2.2 NATURE OF RESOURCES

Rival-ness is an inherent characteristic of certain resources whereby

2.3 NATURAL CAPITAL – ABIOTIC RESOURCES

Fossil Fuels Stock-flow Ye s Ye s Ye s High at margin,

Minerals Stock-flow Ye s Ye s Partially High at margin,

Water Context- Context- Context- Stocks, yes; Non-substitutable

Land Fund-service Ye s Ye s No Non-substitutable

Solar Energy Fund- No No, for No Non-substitutable

Source: Daly and Farley (2004)

Check Your Progress 1

Fig. 2.1: Sustainable Extraction

Source: Daly and Farley (2004)

Source: Daly and Farley (2004)

Check Your Progress 2

2.5 MAN-MADE CAPITAL

2.6 LET US SUM UP

2.7 KEY WORDS

2.8 REFERENCES AND SUGGESTED FURTHER

2.9 KEY TO CHECK YOUR PROGRESS

3.2 MARKET, FUNCTIONING AND EFFICIENCY

Fig. 3.1: Demand, Supply and Equilibrium

3.3 MARKET FAILURE, EXTERNALITIES AND

38 Fig. 3.2: Social Cost

Fig. 3.3: Prices and Volumes of Garbage 39

Do conventional economists really ignore future generations? In a standard economic

PV = Xt /(1 + r)t (1)

3.5 MARKETS, INTERNATIONALIZATION AND

3.6 MARKETS, GLOBALIZATION AND

Fig. 3.4: Marginal External Cost of Deforestation 45