Natural Resources

Natural Resources Definition

Fig. 1 - Forest is an example of natural resource

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.

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.

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.

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.

Natural Resources Examples

Natural resources examples include:

• land
• fossil fuels
• timber
• water
• sunlight
• and even air!

All examples of natural resources can be broadly classified into:

• non-renewable resource use
• renewable resource use

Let's go over these in detail!

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.

Fig. 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.

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.

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.

Fig. 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.