Chapter Four

Natural Resources
Addis Ababa University
College of Business and Economics
Department of Economics
April 2026
 4.1 Classification of Natural resources

I. Based on the Origin of the natural resources

o Biotic resources - Biotic resources are those natural resources that have life in them and
originate from living organisms. Examples include all species of plants and animals,
microorganisms, fossil fuels, etc.
o Abiotic resources - These are resources that have no life in them or originate from non-
living things. Examples include water, air, soil, rocks, minerals, etc.
II. Based on the availability of the resources
o Renewable resources - These are natural resources that can be replenished. The rate at
which they can be replenished exceeds the rate at which they are being used up. Thus,
they are always available. Examples include solar energy, water, wind, etc
o Non-renewable resources- Resources in this category are limited and can be exhausted.
Their formation takes millions of years. Examples include fossil fuels, coal, rare species of
organisms.
Classification of Natural resources
III. Based on Development
o Potential Resources: These are resources that are known to exist, have not been
quantified and can be used for future use. For instance, wind energy exists in
certain areas but has not been used to generate energy.
Example: Wind, nuclear minerals.
o Reserved Resources: They are natural resources that have been identified and
quantified but have not been harnessed because they are being reserved for
future use.
Example: Rivers.
Classification of Natural resources

Example
Reserved resources

o Stock Resources: These are resources that have been discovered, quantified but
have not been harnessed due to insufficient technologies.
Example: Hydrogen.
o Actual Resources: These are resources that have been discovered, quantified,
harnessed, and are being used.
Examples: Crude oil, forest.
4.2 Non-renewable resources
4.2-1 Theory of optimal depletion

4.2-2 Energy resources

4.2-3 Minerals
Essentialness of Natural resources
I. As a waste disposal and reprocessing agent
II. Human Psychic satisfaction (Aesthetic enjoyment)
III. Ecologically essential- (survival of ecosystem services, ecosystem health, energy
flow)
IV. Essential for production (e.g. crude oil is an essential raw material for
production of petrol or paraffin)

In this chapter we are concerned with the essentiality of natural resources for
production of outputs.
4.2-1 Theory of optimal depletion

• Suppose the economy produces Q, which can be consumed or invested.

• Consumption increases current well-being, while investment increases
capital stock, permitting greater consumption in the future.
• Output is generated through a production function using a single
“composite” non-renewable resource input, R, and input manufactured
capital K. Then the production function is :
𝑄 = 𝑄(𝐾, 𝑅)
➢But this doesn’t tell us anything about the particular form of the
relationship. Suppose one possible type of the production technology is the
Cobb-Douglas (CD) production function form;
𝑄 = 𝐴𝐾 ∝ 𝑅𝛽
where 𝐴, ∝, 𝑎𝑛𝑑 𝛽 > 0.
Theory of optimal depletion

• An alternative form of widely used for empirical analysis is the constant

elasticity of substitution (CES) type;
−𝜃 −𝜃 −𝜀ൗ𝜃
𝑄 = 𝐴(∝ 𝐾 + 𝛽𝑅 )
Where 𝐴, 𝜖, 𝛼, 𝛽 > 0, 𝛼 + 𝛽 = 1, −1 < 𝜃 ≠ 0
➢It can be shown that the CD function is a special case of the CES functional
form as 𝜃 goes to zero in the limit.
➢R is assumed to essential if 𝑄 = 𝑄 𝐾, 𝑅 = 0 = 0 for any positive value K.
➢For the CD functional form both R and K are essential as setting any input
equal to zero results in Q=0.
➢For the CES functional form if 𝜃 < 0, 𝑡ℎ𝑒𝑛 𝑛𝑜 𝑖𝑛𝑝𝑢𝑡 𝑖𝑠 𝑒𝑠𝑠𝑒𝑛𝑡𝑖𝑎𝑙, if 𝜃 >
0 𝑡ℎ𝑒𝑛 𝑎𝑙𝑙 𝑖𝑛𝑝𝑢𝑡𝑠 𝑎𝑟𝑒 𝑒𝑠𝑠𝑒𝑛𝑡𝑖𝑎𝑙.
What is the elasticity of substitution between
R and K
• The elasticity of substitution 𝜎, between the non-renewable resource and capital
is defined as the proportionate change in the ratio of capital to the resource in
response to the proportionate change in the ratio of marginal products of capital
and the resource conditional on the total output Q remaining constant.
Elasticity of substitution between R and K
Elasticity of substitution between R and K

I. No input substitution is possible (𝜎 = 0) inputs must be combined in a fixed

proportion, L-shaped isoquant (sometimes known as Leontief production
function).
II. Perfect substitution (𝜎 = ∞), isoquants will be straight lines.
III. If the elasticity of substitution is between this two extremes (0 < 𝜎 < ∞),
isoquant will often be convex to the origin exhibiting greater degree of
curvature the lower the elasticity of substitution, 𝜎.
 Resource substitutability and the
consequences of increasing resource scarcity
• As production continues throughout time, stocks of non-renewable
resources must decline. Continuing depletion of the resource stock
will lead to the non-renewable resource price rising relative to
the price of capital. As the relative price of the non-renewable
resource rises the resource to capital ratio will fall, thereby raising the
marginal product of the resource and reducing the marginal product
of capital.
• However, the magnitude of this substitution effect will depend on the
size of the elasticity of substitution. Where the elasticity of
substitution is high, only small changes in relative input prices will
be necessary to induce a large proportionate change in the
quantities of inputs used. ‘Resource scarcity’ will be of little
consequence as the economy is able to replace the scarce resource
by the reproducible substitute.
 Resource substitutability and the
consequences of increasing resource scarcity

• Low substitution possibilities mean that as resource depletion pushes

up the relative price of the resource, the magnitude of the induced
substitution effect will be small. ‘Resource scarcity’ will have more
serious adverse effects, as the scope for replacement of the scarce
resource by the reproducible substitute is more limited. Where the
elasticity of substitution is zero, then no scope exists for such
replacement.
 The feasibility of sustainable development
• Is sustainable development actually possible?
• To address this question, two things are necessary.
1. A criterion of sustainability is required.
2. We need to describe the material transformation conditions available
to society, now and in the future. These conditions – the economy’s
production possibilities – determine what can be obtained from the
endowments of natural and human-made capital over the relevant
time horizon.
➢ We adopt here a conventional sustainability criterion: non-declining
per capita consumption maintained over indefinite time .
 The feasibility of sustainable development
➢Turning attention to the transformation conditions, it is clear that a large number
of factors enter the picture.
✓ What is happening to the size of the human population?
✓What kinds of resources are available and in what quantities, and what properties
do they possess?
✓ What will happen to the state of technology in the future?
✓ How will ecosystems be affected by the continuing waste loads being placed upon
the environment, and how will ecosystem changes feed back upon productive
potential?
 Transformation possibilities
• To make progress, simplify and narrow down the scope of the problem, by making
an assumption about the form of an economy’s production function.
• A series of results have become established for several special cases. For the CD
and CES functions we have the following.
• CASE A: Output is produced under fully competitive conditions through a CD
production function with constant returns to scale and two inputs, a non-
renewable resource, R, and manufactured capital, K, as in the following special
case of CD production function: 𝑄 = 𝐴𝐾 ∝ 𝑅𝛽
• Then, in the absence of technical progress and with constant population, it is
feasible to have constant consumption across generations if the share of total
output going to capital is greater than the share going to the natural resource (that
is, if α > β).
 Other Cases
• Case B:
• Output is produced under fully competitive conditions through a CES production
function with constant returns to scale and two inputs, a non-renewable resource,
R, and manufactured −𝜀Τcapital, K, as in CES production function: 𝑄 =
−𝜃
𝐴(∝ 𝐾 + 𝛽𝑅 ) 𝜃 −𝜃

• Then, in the absence of technical progress and with constant population, it is

feasible to have constant consumption across generations if the elasticity of
substitution σ = 1/(1 + θ) is greater than or equal to one.
• Case C: Output is produced under conditions in which a backstop technology is
permanently available.
• In this case, the non-renewable natural resource is not essential. Sustainability is
feasible, although there may be limits to the size of the constant consumption
level that can be obtained.
Additional matters
• These results assumed that the rate of technical progress and the rate of
population growth were both zero.
• Results change if one or both of these rates is non-zero.
• The presence of permanent technical progress increases the range of
circumstances in which indefinitely long-lived constant per capita consumption is
feasible.
• Constant population growth has the opposite effect.
• However, there are circumstances in which constant per capita consumption can
be maintained even where population is growing provided the rate of technical
progress is sufficiently large and the share of output going to the resource is
sufficiently low.
Additional matters

• Similarly, for a CES production function, sustained consumption is possible even

where σ < 1 provided that technology growth is sufficiently high relative to
population growth.
• The general conclusion is that sustainability requires either a relatively high degree
of substitutability between capital and the resource, or a sufficiently large
continuing rate of technical progress, or the presence of a permanent backstop
technology.
Discounting
values
Rho
4.3 Renewable resources
4.3 Renewable resources

4.3-1 Biological dimension of fisheries

4.3-2 Theory of optimal use of fisheries

4.3-3 Forest resources: Economic value of forest resources; biological dimension of forestry, and
economic dimension of forest resources
G is stock changes due only to natural causes
Consider a period of time in which the amount of the stock being harvested (H) is equal to the amount
of net natural growth of the resource (G). Suppose also that these magnitudes remain constant over a
sequence of consecutive periods. We call this steady-state harvesting
Next slide
 industry size to industry profitability.
where  is a positive parameter indicating the responsiveness of
Where g is constant parameter greater than zero, is what we have called the intrinsic or
potential growth rate of the population. And, e is a constant number, often called the catch
coefficient. e is some times ignored in a richly specified models.
Figure 17.3
• Figure 17.3 shows equilibrium relationships in stock– harvest space.
• The inverted U-shape curve is the logistic growth function for the resource.
• Three rays emanating from the origin portray the harvest–stock relationships (from the function H = eES) for
three different levels of effort.
• If effort were at the constant level E1, then the unique intersection of the harvest–stock relationship and
biological growth function determines a steady-state harvest level H1 at stock S1.
• The lower effort level E2 determines a second steady-state equilibrium (the pair {H2, S2}).
• EMSY is related to HMSY.
• The various points of intersection satisfy equation 17.17, being equilibrium values of S for particular levels of
E.
• Clearly there is an infinite quantity of possible equilibria, depending on what constant level of fishing effort
is being applied. the equilibrium {E, S} combinations also map into equilibrium {E, H} combinations in
Fig17.4.
Figure 17.4
• The inverted U-shape curve here portrays the steadystate harvests that correspond to each possible effort
level.
• It describes what is often called the fishery’s yield–effort relationship. Mathematically, it is a plot of equation
17.18.
• The particular point on this yield–effort curve that corresponds to an open-access equilibrium will be the one
that generates zero economic profit.
• The zero economic profit equilibrium condition PH = wE can be written as H = (w/P)E.
• For given values of P and w, this plots as a ray from the origin with slope w/P in Figure 17.4.
• The intersection of this ray with the yield–effort curve locates the unique open-access equilibrium
outcome.
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