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Natural Resources

Natural Resources

Have you ever tried to think of natural resources in reverse? Yes, that's right! Instead of thinking that the country's production utilizing natural resources should count positively toward a country's GDP, why not consider extraction of non-renewable resources or pollution of renewable resources as contributing negatively to a country's GDP? We felt that thinking about natural resources in this way would be an interesting perspective. With it, we invite you to continue reading this article to learn more about natural resources in economics!

Natural resources in economics

Natural resources in economics generally pertain to the land factor of production. This means that natural resources constitute all the resources contained within the earth's lower atmosphere that can potentially be used for production.

  • Natural resources include land, fossil fuels, timber, water, sunlight, and even air!

Natural resources are non-human-made assets that can be utilized to produce economic output.

Because natural resources are utilized to produce economic output, economists always consider the costs and benefits of extracting or using a particular resource. These costs and benefits are measured in monetary terms.Although it is difficult to estimate the optimal consumption rates of natural resources, sustainability concerns affect these cost-benefit analyses. After all, if more resources are extracted today, less will be available in the future and vice versa.

Types of natural resources

There are two types of natural resources: renewable resources and non-renewable resources.Renewable natural resources include forests and wildlife, solar and hydropower, and the atmosphere. In other words, renewable resources can regenerate themselves when not over-harvested. Non-renewable resources, on the other hand, include oil, natural gas, coal, and metals. In other words, these resources cannot regenerate themselves and are considered fixed in supply.

Renewable natural resources are resources that can regenerate themselves if harvested sustainably.

Non-renewable natural resources are resources that cannot regenerate and are fixed in supply.

Let's take a look at each of these resource types from the economic point of view.

Renewable natural resources

Economists consider the present value when considering the costs and benefits of projects with renewable natural resources. Consider an example below.

A sole proprietor wants to invest and plant seedlings today with the hope of their great-grandchildren making a living by selling the grown trees. He wants to calculate whether the investment is worth undertaking using a cost and benefit analysis.He knows the following:

  1. 100 square meters of seedlings planting costs $100;
  2. he has 20 land sites, each has an area of 100 square meters;
  3. the current interest rate is 2%;
  4. the trees take 100 years to grow;
  5. the future value of the trees is expected to be $200,000;

He needs to calculate the cost of the investment and compare it to the present value of the investment.The cost of investment:

\(\hbox{Cost of investment}=\$100\times20=\$2,000\)To find the present value of the investment, we need to use the present value formula:

\(\hbox{Present value}=\frac{\hbox{Future value}} {(1+i)^t}\)

\(\hbox{Present value of investment}=\frac{$200,000} {(1+0.02)^{100}}=\$27,607\)Comparing the two values, we can see that the project should be undertaken because the present value of the future benefits outweighs the cost of investment today.

Non-renewable natural resources

When evaluating intertemporal consumption of non-renewable natural resources, economists use cost and benefit analysis accompanied by the present value calculation. Let's take a look at an example below.

A company owns a piece of land and calls geologists to estimate the amount of oil contained within the ground. After drilling some wells and running probes, geologists estimate that the petroleum reservoir will likely have 3,000 tonnes of crude oil. A company is evaluating whether it is worth drilling for oil today or whether it should be preserved for the next 100 years and used then.The company has gathered the following data:

  1. the present cost of extracting and distributing 3,000 tonnes of oil is $500,000;
  2. the profits from the sale in the present will be $2,000,000;
  3. the current interest rate is 2%;
  4. the future value of the oil is expected to be $200,000,000;
  5. the future cost of extracting and distributing 3,000 tonnes of oil is $1,000,000;

The company needs to compare the costs and benefits of the future use with the benefits of the present use.The net benefits of the current use are:

\(\hbox{Net benefits of the present use}=\)

\(=\$2,000,000-\$500,000=\$1,500,000\)To find the net benefits of future use, the company needs to use the present value formula:

\(\hbox{Net benefits of the future use}=\frac{\hbox{(Future value - Future cost)}} {(1+i)^t}\)

\(\hbox{Net benefits of the future use}=\frac{\$200,000,000 - \$1,000,000} {(1+0.02)^{100}}=\$27,468,560\)

Comparing the two values, we can see a strong case favoring conservation instead of consumption today. This is because the present value of the future net benefits outweighs the net benefits available today.

Accounting for the future net benefits of resources is extremely important for conservation and proper management to ensure sustainable resource usage.

Uses of natural resources

There are various uses of natural resources in production. But how do economists take the use of resources over time into account? Of course, they consider opportunity costs! As the stream of benefits that arises from using natural resources usually occurs over time, economists consider potential streams of benefits as well as expenses over time. This means that there is always a trade-off involved. Consuming more of any resource now means that there will be less of it available in the future. In natural resource economics, this is referred to as the user cost of extraction.

The user cost of extraction is the cost economists consider when natural resources are used over time.

Natural resources examples

Let's go over some examples of natural resource uses and their consequences.

Natural resources examples: non-renewable resource use

Consider a firm in the business of extracting a non-renewable resource such as natural gas. Imagine that there are only two periods: the current period (period 1) and the future period (period 2). The firm can choose how to extract natural gas throughout the two periods. Imagine that the price of natural gas per unit is P, and the firm's extraction costs are shown in Figure 1 below.

Extraction costs are associated with the exploration, extraction, processing, and preparation of resources for sale.

Natural Resources Firms costs of natural resource extraction StudySmarterFig. 1 - Firm's costs of natural resource extraction

Figure 1 above shows the firm's costs of natural resource extraction. The cost curves that the firm is facing are upward sloping due to increasing marginal extraction costs.

Marginal extraction cost is the cost of extracting one more unit of a natural resource.

If the firm considers only current costs of extraction (in other words, it decides to mine everything in period 1), its cost curve would be C2. The firm would want to extract Q2 quantity of gas in this period. Any quantity up to point B where the C2 curve crosses the horizontal price level will bring the firm profit.However, if the firm considers the user cost of extraction, denoted by C0 (in other words, it decides to leave some gas in the ground to be mined in period 2), then its cost curve would actually be C1. The firm would want to extract only the Q1 quantity of gas in this period. Any quantity up to a point A where the C1 curve crosses the horizontal price level will bring the firm profit.Note that the C1 curve is a parallel shift of the C2 curve upwards and to the left. The vertical distance between the two curves equals the user cost of extraction, C0. Mathematically:

\(C_1=C_2+C_0\)This example shows that the firms can have incentives to conserve the limited supplies of non-renewable resources. If the firms expect that saving the resource now to extract it in future periods is profitable, then they will prefer to postpone resource extraction.

Natural resources examples: renewable resource use

Consider a firm that manages a renewable resource such as a forest. It plants the trees regularly and only cuts down and sells a sustainable amount of trees that will ensure a continuous supply. The firm is concerned with sustainability as its future profits depend on the constant supply of trees from its land.But how does forestry management consider the costs and benefits of cutting down trees? It considers the tree's life cycle, such as the one shown in Figure 2 below. In other words, the management decides how often their harvesting and replanting will occur.

Natural Resources The life cycle of a tree StudySmarterFig. 2 - The life cycle of a tree

Figure 2 above shows a life cycle of a tree. The three stages of growth are highlighted in three different colors:

  1. slow growth stage (highlighted in yellow)
  2. rapid growth stage (highlighted in green)
  3. zero growth stage (highlighted in purple)

It can be deduced that knowing this life cycle, the forestry management will have an incentive to cut down mature trees which are in stage 2 as they cannot grow more and produce more timber. Cutting the trees in stage 2 and planting new seedlings will allow the firm to better manage the time to allow for more new tree growth, which increases their timber supply. It can also be seen that there is little incentive to cut the trees down early as the rapid growth phase, where the tree accumulates most of its mass, doesn't come until the mid-life cycle of a tree.This example shows that if the forestry management company owns the land, in other words, it has secure property rights over the land on which it grows its trees, it will have an incentive to harvest trees sustainably. There is also a strong incentive to continue replanting new trees to ensure a continuous supply.On the other hand, if property rights were not enforced, forestry would become over-used and under-replenished, leading to deforestation. This is because without property rights in place, individuals will only consider their private benefits and not take the social costs of deforestation into account, just like in the case of negative externalities.

Natural Resources - Key takeaways

  • Natural resources are non-human-made assets that can be utilized to produce economic output.
  • Renewable natural resources are resources that can regenerate themselves if harvested sustainably.Non-renewable natural resources are resources that cannot regenerate and are fixed in supply.
  • The user cost of extraction is the cost economists consider when natural resources are used over time.
  • Extraction costs are associated with the exploration, extraction, processing, and preparation of resources for sale.
  • Marginal extraction cost is the cost of extracting one more unit of a natural resource.

Frequently Asked Questions about Natural Resources

Natural resources are non-human-made assets that can be utilized to produce economic output.

The benefit of natural resources is that they can be converted into economic output.

Natural resources positively affect economic growth because they are used in the production of economic output.

The role of natural resources in the economy is to be transformed into economic output.

Natural resources include land, fossil fuels, timber, water, sunlight, and even air!

Final Natural Resources Quiz

Question

What are natural resources?

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Answer

Natural resources are non-human-made assets that can be utilized to produce economic output.

Show question

Question

What is the benefit of natural resources?

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Answer

The benefit of natural resources is that they can be converted into economic output.

Show question

Question

How do natural resources affect economic growth?

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Answer

Natural resources positively affect economic growth because they are used in the production of economic output.

Show question

Question

What is the role of natural resources in the economy?

Show answer

Answer

The role of natural resources in the economy is to be transformed into economic output.

Show question

Question

What are natural resources examples?

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Answer

Natural resources include land, fossil fuels, timber, water, sunlight, and even air!

Show question

Question

To which factor of production do the natural resources generally pertain?

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Answer

land.

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Question

Define natural resources.

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Answer

Natural resources are non-human-made assets that can be utilized to produce economic output.

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Question

What are the two types of natural resources?

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Answer

Renewable and non-renewable resources.

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Question

What are renewable natural resources?

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Answer

Renewable natural resources are resources that can regenerate themselves if harvested sustainably.

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Question

What are non-renewable natural resources?

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Answer

Non-renewable natural resources are resources that cannot regenerate and are fixed in supply.

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Question

What is the user cost of extraction?

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Answer

The user cost of extraction is the cost economists consider when natural resources are used over time.

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Question

What activities are extraction costs associated with?

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Answer

Extraction costs are associated with the exploration, extraction, processing, and preparation of resources for sale.

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Question

Define marginal extraction cost.

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Answer

Marginal extraction cost is the cost of extracting one more unit of a natural resource.

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