FREC 424 Resource Economics -- Introduction

By definition, economic "goods" are scarce. It is the scarcity of a market good, not its usefulness, that determines its price. Many economic goods are not market goods, however. Clean air or water, safety and health are examples of non-market goods that have economic values but lack markets that reveal those values as prices. Conversely, economic "bads" such as crime and pollution are in excess supply.

We identify three main resource management objectives: efficiency, equity and sustainability. The major focus of this course is the positive analysis of allocative efficiency:

  • Under what conditions do markets allocate resources to their highest-valued uses at the most appropriate times?
  • Under what conditions do markets fail to achieve theese efficient resource allocations?
  • What is the best way to correct these allocative inefficiencies?
These are "positive" economic questions in the sense that economists have the analytical tools to make objective determinations of economic efficiency.

One common criterion of economic efficiency was defined by the economist Vilfredo Pareto: a distribution of resources among individuals is efficient as long as no one can be made better off without someone else being made worse off.

The Edgeworth Box is a diagram of this concept.  If there are fixed quantities of two goods, X and Y, to be allocated between two individuals, A and B, we can represent the 2-good space as a rectangle, plot A's indifference curves as radiating northeastward from her origin at the lower left, and plot B's indifference curves as radiating southwestward from his origin at the upper right (B gets the units of X and Y that A doesn't get). If A and B can trade freely, they will trade to some point along the green line ("contract curve"), which is the set of all points where their indifference curves are tangent and their marginal rates of substitution between X and Y (the slopes of the indifference curves) are equal.


Note that the Pareto-efficiency criterion does not address issues of equity (fairness) in the a priori distribution of goods or resources.  For example, an allocation where A gets everything and B gets nothing would be Pareto-efficient.  A logical extension of the Pareto-efficiency concept is that any redistribution of resources among individuals is efficient only if the gainers from the redistribution could fully compensate the losers and still be better off.

Equity issues fall in the realm of normative economics, which deals with analyses of "what should be," and involve more subjective ethical judgments.

Finally, sustainable resource use implies future generations will be at least as well off as we are. Tietenberg discusses three increasingly restrictive interpretations of this concept:

  1. The overall economic welfare of future generations (the aggregate value of natural and human made capital combined) should not decline. (Natural capital can be converted into human-made capital.)
  2. The aggregate value of natural capital should never decline. (A decline in quantity of natural capital is okay if offset by an increase in its per-unit value)
  3. The aggregate flow of physical services from natural capital should never decline. (This may require no decline in quantity of natural capital at all.)

Economics is inherently anthropocentric: we are analyzing the choices made by people and the underlying values of natural resources to people, as reflected in those choices. This is not necessarily a narrow focus. Obviously many natural resources, including most environmental quality amenities, are not market goods, and their values to people are not expressed in market prices. So economists have developed several techniques for guaging the non-market values of things such as biodiversity and air quality, and empirical applications of these methods indicate such values are indeed substantial. The anthropocentric framework is broad enough to encompass peoples' appreciation for the simple "existence value" of resources, independent of any human use of them. At least in theory, this concept of existence value could even be extended to resources about which people are unaware!

This course analyzes how market allocate resources between uses and through time. Briefly, we define economic efficiency as maximizing the stream of net benefits accruing from the resource stock across all uses and time periods.

Net benefits are defined as total benefits minus total costs. Total benefits are measured as "total willingness to pay:" the area under the market demand curve up to the market equilibrium quantity. Total costs are measured as the area under the supply curve up to the market equilibrium quantity. Total benefits minus total costs equals total economic surplus, the sum of consumer surplus and producer surplus.


Consumer surplus is the total dollar amount consumers would be willing to pay for the market equilibrium quantity above what they actually do pay. Producer surplus is the total dollar amount producers actually receive for the market equilibrium quantity above what they would be willing to accept.

Consider the effects of a market distortion, such as a rent-control policy in a city.  The following graph illustrates the consequences of a price-ceiling: supply is reduced, creating a black market price higher than the original equilibrium price.  The result is an economic deadweight loss (DWL) a quantitative measure of the aggregate economic waste caused by the policy: here the loss in producer surplus is far larger than any gain in consumer surplus.


The long-term effects of an urban rent-control program can be devastating:  Rental caps leave landlords no incentive to maintain properties, the neighborhood becomes a slum, the tax base collapses, buildings are eventually abandoned and no new housing gets built.  The South Bronx was a good example.  City ordinances that require landlords to maintain their properties simply motivate owner abandonment.

An optimal allocation implies that the marginal net benefits accruing from the resource in each use are equal, and the time-discounted marginal net benefits accruing from the resource in each time period are equal.

Discounting allows us to compare net benefits across time periods. The discount rate is a social rate of time preference: we would rather have benefits today rather than next year, so we "discount" next years benefits slightly relative to current benefits. Financial interest rates reflect this discount rate as well as inflationary expectations and risk costs.

Students are frequently surprised to see that competitive markets can achieve near-optimal allocations of resources. Monopolistic markets generally result in excess conservation. Various other market failures also compromise allocative efficiency. For example, some "common property" or "open-access" resources such as marine fisheries are vulnerable to over-harvesting; non-excludable "public goods" such as scenic quality are typically under-supplied.