2020 Unit 3 - Basics of Natural Resource Economics EBL3852 PDF

UNIT 3: Basics of Natural Resource Economics  UNIT LEARNING OUTCOMES By the end of this Unit, students should be able to: 1. Define natural resource economics. 2. Distinguish among the different economic systems. 3. Explain the concept of Cost-Benefit Analysis (CBA) a...

UNIT 3: Basics of Natural Resource Economics  UNIT LEARNING OUTCOMES By the end of this Unit, students should be able to: 1. Define natural resource economics. 2. Distinguish among the different economic systems. 3. Explain the concept of Cost-Benefit Analysis (CBA) and the process followed. 4. Discuss the approaches used to place money values on non-market goods and services. 5. Discuss the different economic valuation approaches.  Contents Introduction & definitions. Economic Systems Cost Benefit analysis(CBA). Placing money values on non-market goods and services. Economic valuation approaches/methods.  ECONOMIC SYSTEMS Economic systems are the means by which countries and governments distribute resources and trade goods and services. They are used to control the factors of production, including: o labour, o capital, o entrepreneurs, o physical resources, and o information resources. Markets enable mutually beneficial exchange between producers and consumers.  ECONOMIC SYSTEMSS There are several economic systems and they differ in the way they answer the economic questions of: a) WHAT to produce. b) HOW to produce. c) FOR WHOM to produce.  Economic Systems A) FREE MARKET ECONOMIES Resource allocation is done through free and self directed market forces. Meaning that consumers determine WHAT to produce. Producers determine HOW to produce. WHO products get to is determined by buying power of consumers. Direct interaction between producers and consumers is driven by self- interest  ECONOMIC SYSTEMS Advantages of a Market Economy a) Competition leads to efficiency because businesses that have fewer costs are more competitive and make more money. b) Innovation is encouraged because it provides a competitive edge and increases the chance for wealth. c) A large variety of goods and services are available as businesses try to differentiate themselves in the market. d) Economic activity is encouraged because you need money to live and need to engage in economic activity (through employment or self-employment) to make money. e) Freedom of individual choice is possible to the extent that the market provides options for work, developing a business, and purchasing goods and services (so long as you can afford them).  ECONOMIC SYSTEMS Disadvantages of a Market Economy a) Disparity in wealth exists because wealth tends to generate wealth (it's easier for wealthy individuals to become wealthier). b) Environmental damage may happen with no government regulations because it is usually more expensive to produce in an environmentally sound manner, which reduces profits. c) Reduced social safety net (e.g., insurance, social security, medical care) because these programmes are supported through taxation. d) Poor working conditions may prevail due to a lack of government regulations because health and safety cost money, thus reducing profits. e) Questionable priorities can result when the overriding decisions regarding production are profit-motivated rather than serving the needs of the people.  Economic Systems B) COMMAND ECONOMIES When governments demand or direct resources to be used in a particular way. Often referred to as central planning method. Eg. Taxes that are demanded and used to build infrastructure. This is particularly advantageous when resources are scarce. Free markets would not result in the unequitable use of scarce resources as every role player acts in its own interest. Also allows for better coordination of scarce resources in time of crisis eg, natural disaster then free market economies.  ECONOMIC SYSTEMS Advantages of a Command Economy a) Less inequality: Because the government controls the means of production in a command economy, it determines who works where and for how much pay. b) Low unemployment levels: Government can set wages and job openings and wage distribution that it sees fit. c) Common good v/s Profit priority: Government can tailor products and services to benefit the common good without regard to profits and losses. d) Considerations of national security are well taken care of.  ECONOMIC SYSTEMS Disadvantages of a Command Economy a) Lack of competition inhibits innovation and keeps prices from resting at an optimal level for consumers. b) System inefficiencies are common when the government controls every aspect of a country's economy (red tape, high operating and administrative costs, etc.) c) Production is notoriously inefficient as the government feels no pressure from competitors or price-conscious consumers to cut costs or streamline operations d) They also may be slower to respond – or even completely nonresponsive – to consumer needs or changing tastes.  Economic Systems C) MIXED ECONOMIES Combines both central planning and free market forces. Therefore has both a private and public sector. In reality most economies are mixed, the difference lies in the varying degrees at which mixing occurs. Eg. Cuba the vast majority of resource allocation is done by the state whilst in Europe it is more equal and the US greater leverage is given to free market economies Degree of mixing is often determined by the economic objectives of the particular country.  ECONOMIC SYSTEMS Advantages of Mixed Economy a) It encourages private initiative. b) There is freedom of choice for consumers and producers. c) It ensures better economic development. d) It ensures job security and employment. e) Monopoly is prevented because of the joint participation in economic activities by both the private and public sectors.  ECONOMIC SYSTEMS Disadvantages of Mixed Economy a) There is more emphasis on profit at the expense of the welfare of the citizens. b) There is usually high level of corruption and mismanagement. c) Wealth is not equitably distributed as there is a gap between the rich and the poor. d) Efficiency hardly occurs in this type of economy because of involvement of the State. e) Exploitation of labour may take place. WHAT IS NATURAL RESOURCE ECONOMICS? Natural resource economics deals with the interconnectedness between human economies and natural ecosystems. It focuses on the supply, demand, and allocation of the Earth’s natural resources.  Natural resources economics Natural Resources in the economic context is broadly defined as natural capital assets that are not created by human activity. Natural resources can be factors of production or goods that can be traded in the market. More often they are the reason for (indirect use capacity) rather than tradeable goods in their own right. WHAT IS NATURAL RESOURCE ECONOMICS? The main objective of natural resource economics is to gain a better understanding of the role natural resource play in the economy. The purpose is to develop more sustainable methods of managing the natural resources. Natural Resource Economists study how economic and natural systems interact in order to develop an efficient economy. COST-BENEFIT ANALYSIS (CBA)  QUIZ 2 21/08/2024  COST-BENEFIT ANALYSIS (CBA) What is environmental accounting? ▪ It is a system for providing accurate and quantitative measures of the costs and effects, efficiency and effectiveness of investments in environmental conservation activities. ▪ The benefit of undertaking an environmental accounting initiative is the identification and greater awareness of environment-related costs which provides the opportunity to find ways to reduce or avoid these costs. ▪ Environmental accounting links the economy to the biophysical environment.  COST-BENEFIT ANALYSIS (CBA) ▪ It enables people to understand the full spectrum of environmental costs and integrate these costs into decision- making. ▪ Adoption of environmental accounting techniques increases the visibility of environmental costs and benefits, thus increasing cost manageability. ▪ One approach to evaluating the environmental costs and benefits is Cost-Benefit Analysis (CBA). ▪ Cost-Benefit Analysis (CBA) is a systematic technique used to compare the costs and the benefits of projects and policies expressed in monetary terms.  COST-BENEFIT ANALYSIS (CBA) The aim is to establish whether the benefits exceed the costs, and if so, by how much. CBA has its origins in the water development projects of the U.S. Army Corps of Engineers. In 1936 U.S. Congress passed the Flood Control Act which contained the wording, “The Federal Government should improve or participate in the improvement of navigable waters or their tributaries, including watersheds thereof, for flood-control purposes if the benefits to whomsoever they may accrue are in excess of the estimated costs."  RECALL: Cost-Benefit Analysis CBA aims to compare the monetary costs and monetary benefits of any project or policy; Determines whether the benefits outweigh the costs. Assumption is that if benefits are greater than costs then the project should proceed, and vice versa. Underlying justification for CBA lies within the theory of welfare economics. That is, Government to select those projects that maximize social welfare (doing what is best for the whole of society, even some groups suffer some costs). COST-BENEFIT ANALYSIS (CBA): Steps  COST-BENEFIT ANALYSIS (CBA): Steps Project definition Classification of impacts Conversion into monetary terms Project assessment Risk assessment and management  COST-BENEFIT ANALYSIS (CBA): Steps STEP 1: SPECIFY THE SET OF OPTIONS (IDENTIFY SCOPE) ▪ Details of the proposed programme, project, initiative or service offering must be outlined. This allows organizations to understand what is being evaluated, as well as the relationship it has to the problem or challenge being addressed. This includes stating the background, current challenges, and environmental setting in relation to the proposed initiative. ▪ Consider a number of options including a ‘do nothing’ or ‘business as usual’ option which will provide the base case against which the costs and benefits of each alternative are compared.  COST-BENEFIT ANALYSIS (CBA): Steps STEP 2: DECIDE WHOSE COSTS AND BENEFITS COUNT Once the scope is defined, costs should be identified and categorized – make a decision whose costs and benefits count. As far as is practical, you should count the costs and benefits to all people impacted by the proposed initiative. Compile a comprehensive list of costs and benefits of the project. It is important to distinguish whether costs are one-time, fixed or variable.  COST-BENEFIT ANALYSIS (CBA): Steps STEP 3: IDENTIFY THE IMPACTS AND SELECT MEASUREMENT INDICATORS Explicitly identify the ways in which the proposal makes individuals better or worse off. All the effects of a proposal that are considered desirable by those affected are benefits; all undesirable effects are costs. Identify the full range of impacts of each of the options (relative to the base (the ‘business as usual’ scenario). The choice of indicators to measure the impacts depends on data availability and ease of monetisation. E.g., a proposal may reduce risks of a hazard. Its positive impact could be measured in terms of a reduced number of accidents. The benefit from accidents avoided could be valued in dollars (see Step 5).  COST-BENEFIT ANALYSIS (CBA): Steps STEP 4: PREDICT THE IMPACTS OVER THE LIFE OF THE PROPOSED INITIATIVE The impacts should be quantified for each time period over the life of the proposed initiative. Because of the uncertainty involved in forecasting costs and benefits over long periods, caution should be exercised when doing an evaluation over a long period. Predicting future impacts is difficult - there will always be some uncertainty about the outcome of a proposed initiative.  COST-BENEFIT ANALYSIS (CBA): Steps A CBA should present the best estimates of expected costs and benefits, along with a description of the major uncertainties and how they were taken into account. Although it is difficult to predict the effects over a long period of time —decisions require some assumptions to be made. oHence, the assumptions must be made transparent so as to improve implementation planning and to help identify where more effort should be made to improve the analysis. COST-BENEFIT ANALYSIS (CBA): Steps STEP 5: MONETISE (PLACE DOLLAR VALUES ON) IMPACTS Assigning a dollar value of the costs and benefits of an initiative should be done to measure the effects of the proposed change. This is referred to as monetizing the costs and benefits. The value could be positive or negative depending on whether the change makes them better or worse off. All values are summed up and the total cost is compared to total benefits. There may be challenges with distributional considerations (equity issues) – an action has different impacts on different classes of society. o The principle of $1 gain to one person cancels a $1 loss to another may not be practical.  COST-BENEFIT ANALYSIS (CBA): Steps Dollar values can be estimated by observing how much people actually pay for certain goods or services, and the quantities of those goods and services that are consumed. o Market behaviour reveals people’s valuations (or is at least a good guide to them). Monetisation can be difficult because impacts are sometimes uncertain, some are difficult to value in dollar terms, and some are both uncertain and difficult to value. o Environmental goods are examples of goods that are difficult to place dollar values on, as they are typically not traded in markets. Various methods for estimating the value of non- market goods are discussed in the next section. PLACING MONEY VALUES ON NON-MARKET GOODS AND SERVICES  PLACING MONEY VALUES ON NON-MARKET GOODS ▪ Money is the only practicable comparative measure, but its use causes considerable problems when the identified costs and benefits have no established market price. This applies to a range of environmental goods and services – landscape amenity, clean air, etc., which are simply not marketed. ▪ The need arises to devise surrogate monetary value measures. Numerous alternative approaches have been suggested of which five have been most widely used: 1: Estimation of physical damage costs 2: Damage or Risk avoidance payments 3: Property and land value change 4: Consumer surplus calculations 5: Compensation or Bribe estimation  PLACING MONEY VALUES ON NON-MARKET GOODS 1: Estimation of physical damage costs ▪ CBAs have attempted to place prices on amenity losses, but there is no really meaningful way to express aesthetic losses suffered by individuals in financial terms. ▪ E.g., Attempts to put a cost figure on damage imposed by air pollution related to corrosion of buildings, paintwork, household fabrics, etc., by using comparisons of cleaning, repair, and maintenance costs in polluted and non-polluted areas have been done. This approach has problems of isolating the effects of pollution from other variables which could influence the spatial distribution of material damage (e.g., rainfall variations, sunshine hours, frost incidence). PLACING MONEY VALUES ON NON-MARKET GOODS ▪ Major difficulties also arise in putting a price on illness or death. ▪ One common approach is to calculate the reduction in productive output minus (in case of death) the saved consumption of the affected individuals. This has been criticized on moral grounds that human life cannot be treated as a piece of productive machinery. ▪ This is widely used in insurance assessments and in court decisions on damage claims. Major difficulty lies in the calculation of productive output. ▪ Death of old-age pensioners or the unemployed would be a net economic gain since the lost output would be zero. ▪ If income is used as the measure of output, the premature loss of an engineer would be much more significant than that of a farm worker. PLACING MONEY VALUES ON NON-MARKET GOODS 2: Damage or Risk avoidance payments ▪ Attempts have been made to calculate the level of expenditure on damage or risk avoidance. ▪ Household spending on things such as flood insurance, double- glazing to reduce noise, hedges to obscure sources of visual intrusion have been employed to obtain minimum estimates of the value of the control measures of hazard reduction. ▪ Limitations: some households will not be able to pay the avoidance costs. short-term tenants will be unlikely to incur costs for benefits accruing to subsequent tenants and the landlord. some of the structures may be erected simply because they are fashionable.  PLACING MONEY VALUES ON NON-MARKET GOODS 3: Property and land value change ▪ Based on the idea that the value of a property should reflect intrinsic qualities and its surrounding environment, as perceived by the purchaser. All calculations based on land or house values have problems that property markets are highly imperfect. Major price increments occur when new recreational sites are provided or when areas are designated as conservation areas.  PLACING MONEY VALUES ON NON-MARKET GOODS 4: Consumer surplus calculations ▪ The consumer surplus can be defined as the maximum sum of money a consumer would be willing to pay for a given amount of good or service, less the amount actually paid. This is critical in the measurement of social benefits. ▪ A much-criticized element is the way values are calculated for savings: arbitrary and highly subjective values placed on time can act to sway the results of the assessment towards a development. PLACING MONEY VALUES ON NON-MARKET GOODS 5: Compensation or Bribe estimation ▪ Involves finding out how much would people need in compensation or bribes to make up for their loss (willingness to accept). ▪ This can be done by sample surveys which ask households hypothetical questions such as `What is the minimum sum you would accept to reconcile yourself to the increase in aircraft noise to which you are subjected?’ ▪ Not only will the result depend on the wealth of those interviewed but also the subjective evaluations made in a survey situation are unlikely to bear much relation to those actually made under real market conditions. PLACING MONEY VALUES ON NON-MARKET GOODS ▪ Alternatively, since the principle of compensation is widely accepted in most societies, it might be possible to use: court awards, insurance settlements, or levels of compensation actually paid by private and public agencies on a whole range of disamenities.  RECAP Factors affecting production Economic Systems Advantages and disadvantages Natural resource economies Cost Benefit analysis(CBA). Placing money values on non-market goods and services Economic valuation approaches/methods. ECONOMIC VALUATION APPROACHES  WHAT IS VALUATION? The process of determining the value of an asset, or company, or an investment. ✓Value = worth, desirability or utility. ✓Asset = any item of economic value owned by an individual or corporation, especially that which could be converted to cash. Environmental valuation = placing a value or price on environmental goods and services that are left out of market transaction. Valuation measures the value people place on an environmental service and is measured in terms of their willingness to pay (WTP) and their willingness to accept (WTA) a change in an ecosystem service. There are many techniques for valuation, and it is often partially objective and partially subjective.  WHAT IS VALUATION? ▪ Valuation is needed because price does not equal value for most environmental goods and services, because: Incomplete, or missing markets or property rights Public/common access goods Issue of externalities ▪ Valuation is important in addressing a number of policy issues, e.g.: Determining the most cost-effective way to protect the environment. To inform Cost Benefit Analysis. Costing any environmental (and related) damage. Valuation is needed because price does not equal value for most environmental goods and services, because →incomplete, or missing markets or property rights →public/common access goods →externalities  WHAT IS VALUATION? https://www.researchgate.net/figure/3-Steps-of-inference-required-to-link-ecosystems-and-biodiversity-to-human-well-being_fig3_259772139  VALUATION METHODS ▪ In order to come up with accurate economic values of non- market goods and services (e.g. environmental good or service) we need to identify the various components that make up its Total Economic Value (TEV). Use value (UV) Direct use values Indirect use values Non-use value (NUV). Bequest: represents the importance people place on preserving or maintaining ecosystems for future generations. Existence: reflects the psychological benefits that accrue from the mere knowledge that a good exists and will continue to exist. VALUATION METHODS (Source: Abdullah et al, 2011)  The “total economic value” of a change in the environment can be decomposed into types Pearce et al. (2006, Chp. 6) Total economic value “passive use” Direct use Indirect use The “total economic value” of a change in the environment can be decomposed into types Pearce et al. (2006, Chp. 6) Total economic value the benefit or pleasure the benefit of physically derived from the experiencing, using or knowledge that an “consuming” an (environmental) good (environmental) good exists without using it. “passive use” Direct use Indirect use  The “total economic value” of a change in the environment can be decomposed into types Pearce et al. (2006, Chp. 6) Total economic value the benefit or pleasure the benefit of physically derived from the experiencing, using or knowledge that an “consuming” an (environmental) good (environmental) good exists without using it. “passive use” benefit from afar of Direct use Indirect use preserving some amenity (not physically experienced) from preserving from perceived the opportunity value to future of future use generations The “total economic value” (TEV) of a change in the environment can be decomposed into types Pearce et al. (2006, Chp. 6) Total economic value “passive use” Ex.: Ex.: species, bioprospecting, ecosystems, Direct use Indirect use species range natural wonders expansion under Ex.: recreation, Ex.: regulation of environmental hunting, water runoff, change extraction carbon (forest, fish, sequestration drinking/irrigati on. water) Pearce et al. (2006, Chp. 6)  VALUATION METHODS ▪ Valuation approaches can be divided according to whether they use market or non-market information/data. ▪ Market methods provide an indication of value by comparing with comparable (or similar) goods or services for which price information is available (market price) ▪ Non-market methods Stated preference (SP) methods – use individual respondents' statements about their preferences to estimate change in utility associated with a proposed increase in quality or quantity of an ecosystem service or bundle of services (Bateman, Carson et al. 2002). Revealed preference (RP) methods – these are indirect and use market data based on established and actual recorded behaviour.  VALUATION METHODS 1. Market price method * 2. Effect on production method * Market-based 3. Cost-based Methods * 4. Travel Cost Method Revealed Preference 5. Hedonic Price Method 6. Contingent valuation method Stated Preference 7. Choice experiment 8. Benefit transfer *We will focus on these 3 Methods Pirard, R., Lapeyre, R.(2014). Classifying market-based instruments for ecosystem services: A guide to the literature jungle. Ecosystem Services (2014), http://dx.doi.org/10.1016/j.ecoser.2014.06.005  ECONOMIC VALUATION: Market Price Method Estimates the value of ecosystem services based on the market price. It is used mostly for provisioning services (eg. food, raw materials, fresh water, medicinal plants) that are traded in a market. Measures value per unit or volume (in relation to market value) for existing supply or changes in the supply. Seasonal variations and other effects on price must be considered.  ECONOMIC VALUATION: Market Price Method Strengths Weaknesses Data is relatively easy to obtain for established Market value only available to a limited number of markets ES Uses observed data of actual consumer … tends to reflect only the use value of ES preferences …might not reflect true economic value due to Uses standard, accepted economic techniques market failures …usually doesn’t deduct the market value of other resources used to bring products to the market ECONOMIC VALUATION: Effect on Production Method (production function) The technique measures how much an Ecosystem Service contributes to increasing the productivity of another ES. It values the increase (or decrease) in production based on environmental improvement (or degradation). It establishes a biophysical or dose-response function that shows the causal relationship between a change in an Ecosystem Service and the dependent production process. It is commonly used to valuate regulating and supporting services (eg. pollination, fish breeding habitat). Requires market information to value changes in the production of ecosystem-dependent products. The challenge lies in determining the biophysical or dose-response relationship that links the changes in the supply or quality of ES to the changes in the production It requires expert consultation, laboratory/field research, controlled experiments, modelling and statistical regression ECONOMIC VALUATION: Effect on Production Method (production function) Strengths Weaknesses Collecting data might be difficult and Simple, straight forward thinking costly Level of uncertainty on causal links Clearly links ES with outputs and between ES-status and economic income in other sectors of the economy production When information is available Attribution is not always clear (market, (biophysical, market) it can be cheap economic, institutional influences) and quick Changes in ES status might have an effect on real prices – another layer of complexity! ECONOMIC VALUATION: Cost-Based Methods Estimation of amount of money that is saved due to the availability of ecosystem services. ❖ Replacement cost Uses the costs of replacing or replicating an ecosystem service with artificial or human- made technologies or infrastructure to valuate ecosystem service. This is done by identifying the benefits of an ecosystem service, how it is used and by whom, and the magnitude and extent of these benefits. It also identifies the most likely alternative source of product, infrastructure or technology that would provide an equivalent level of benefits to an equivalent population. Finally the costs of introducing, distributing and maintaining the replacement to the ecosystem service is calculated so as to valuate the ecosystem service. ECONOMIC VALUATION: Cost-Based Methods Avoided damage cost Costs and losses that occur when the loss of an ecosystem service results in damage to property or production. This is done by identifying the protective services of the ecosystem, including the degree of protection afforded and the on- and offsite damages that would occur as a result of a loss of this protection. The infrastructure is located or human population that would be affected by this damage and a cut-off point determined beyond which effects will not be analyzed. Information is also obtained on the likelihood and frequency of damaging events occurring under different scenarios of ecosystem loss, the spread of their impacts and the magnitude of the damages. Then these damages are calculated and in this way the contribution of the ecosystem service towards minimizing or avoiding them is ascribed.  ECONOMIC VALUATION: Cost-Based Methods Strengths Weaknesses *RC: not strictly speaking the economic value Conceptually easy to understand of a good (value based on preferences) Relatively simple to implement Both: hypothetical Avoidance cost : ability to isolate impact Replacement cost: difficult to substitute Both: other aspects of value  GENERAL CHALLENGES OF ECONOMIC VALUATION It can be an expensive exercise especially where data must be gathered in the field or expertise are needed in computing software. Expensive. Time consuming. Uncertain and open to criticism. Most public policy decisions are political and not economic based. Things that may be most important to us are often most elusive to economics (love, relationships, values, spirituality).  UNIT LEARNING OUTCOMES By the end of this Unit, students should be able to: 1. Define natural resource economics. 2. Distinguish among the different economic systems. 3. Explain the concept of Cost-Benefit Analysis (CBA) and the process followed. 4. Discuss the approaches used to place money values on non-market goods and services. 5. Discuss the different economic valuation approaches.