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Chapter 15 Natural Resource and Energy Economics
QUESTIONS
1. Describe Thomas Malthus’ theory of human reproduction. Does it make sense for some
species—say bacteria or rabbits? What do you think makes humans different?
LO1
Answer: Thomas Malthus’ theory of reproduction is that as living standards (specifically
the food supply from Malthus’ perspective) rise above subsistence, people will tend to
have more children (they can afford them) and population will grow. Eventually,
2. Demographers have been very surprised that total fertility rates have fallen below 2.0,
especially because most people in most countries tell pollsters that they would like to have at least
two children. Can you think of any possible economic factors that may be causing women in so
many countries to average fewer than two children per lifetime? What about other social or
political changes? LO1
Answer: There are a number of factors that could lead to the decline, including greater
3. Resource consumption per person in the United States is either flat or falling, depending on the
resource. Yet living standards are rising due to improvements in technology that allow more
output to be produced for every unit of input used in production. What does this say about the
likelihood of our running out of resources? Could we possibly maintain or improve our living
standards even if the population were expected to rise in the future rather than fall? LO1
Answer: The fact that we are able to raise living standards without using as many
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4. Suppose that you hear two people arguing about energy. One says that we are running out of
energy. The other counters that we are running out of cheap energy. Explain which person is
correct and why. LO3
Answer: The second person may be correct; the first is not. There will always be sources
of energy available (flowing water, the wind, and the sun, if nothing else), but some
5. A community has a nighttime energy demand of 50 megawatts but a peak daytime demand of
75 megawatts. It has the chance to build a 90‐megawatt coal‐fired plant that could easily supply
all of its energy uses even at peak daytime demand. Should it necessarily proceed? Could there be
lower‐cost options? Explain. LO2
Answer: A large coal fired plant likely has high fixed costs. It may have lower operating
costs than other energy sources, but if those lower costs (economies of scale) are only
6. Recall the model of nonrenewable resource extraction presented in Figure 15.7. Suppose that a
technological breakthrough means that extraction costs will fall in the future (but not in the
present). What will this do to future profits and, therefore, to current user cost? Will current
extraction increase or decrease? Compare this to a situation where future extraction costs remain
unchanged but current extraction costs fall. In this situation, does current extraction increase or
decrease? Does the firm’s behavior make sense in both situations? That is, does its response to
the changes in production costs in each case maximize the firm’s stream of profits over time?
LO4
Answer: A reduction in future extraction costs will increase future profits, increasing
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7. If the current market price rises, does current extraction increase or decrease? What if the
future market price rises? Do these changes in current extraction help to ensure that the resource
is extracted and used when it is most valuable? LO4
Answer: An increase in the current market price, all else equal, would increase the
profitability of current extraction. This would lead firms to extract more in the present.
8. ADVANCED ANALYSIS Suppose that a government wants to reduce its economy’s
dependence on coal and decides as a result to tax coal mining companies $1 per ton for every ton
of coal that they mine. Assuming that coal mining companies treat this tax as an increase in
extraction costs this year, what effect will the tax have on current extraction in the model used in
Figure 15.7? Now, think one step ahead. Suppose that the tax will be in place forever, so that it
will also affect extraction costs in the future. Will the tax increase or decrease user cost? Does
this effect increase or decrease the change in current extraction caused by the shift of the EC
curve? Given your finding, should environmental taxes be temporary? LO4
Answer: If the tax only increases current extraction costs (i.e. will not be extended into
the next period), current extraction will be less profitable and less will occur. If,
9. ADVANCED ANALYSIS User cost is equal to the present ‐value of future profits in the
model presented in Figure 15.7. Will the optimal quantity to mine in the present year increase or
decrease if the market rate of interest rises? Does your result make any intuitive sense? (Hint: If
interest rates are up, would you want to have more or less money right now to invest at the market
rate of interest?) LO4
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Answer: An increase in market interest rates will reduce the present value of a future
10. Various cultures have come up with their own methods to limit catch size and prevent fishery
collapse. In old Hawaii, certain fishing grounds near shore could be used only by certain
individuals. And among lobstermen in Maine, strict territorial rights are handed out so that only
certain people can harvest lobsters in certain waters. Discuss specifically how these systems
provide incentives for conservation. Then think about the enforcement of these property rights.
Do you think similar systems could be successfully enforced for deep‐sea fishing, far off shore?
LO5
Answer: Those given rights to a certain fishery have an incentive to harvest at a
sustainable rate so that they can generate a long-run stream of profits. If the area to be
11. Aquaculture is the growing of fish, shrimp, and other seafood in enclosed cages or ponds. The
cages and ponds not only keep the seafood from swimming away but also provide
aquaculturalists with strong property rights over their animals. Does this provide a good incentive
for low‐cost production as compared with fishing in the open seas where there are few if any
property rights? LO5
Answer: By having property rights over the fish, aquaculturalists have strong incentives
12. LAST WORD The figure in the Last Word section shows that a 10‐fold increase in a
country’s GDP per person is associated with about a 20‐point increase in EPI. On the other hand,
GDP per person was $38,165 in the United States in 2007 but only $32,775 in Switzerland
despite the fact that Switzerland had an EPI score of 95.5 while the United States had an EPI
score of only 81.0. So does getting rich guarantee doing well environmentally? Discuss.
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Answer: The data suggests that there is a strong positive relationship between the wealth
of a country and environmental quality. The figure in the last word shows that a 10-fold
PROBLEMS
1. Suppose that the current (first) generation consists of 1 million people, half of whom are
women. If the total fertility rate is 1.3 and the only way people die is of old age, how big will the
fourth generation (the great‐grandchildren) be? How much smaller (in percentage terms) is each
generation than the previous generation? How much smaller (in percentage terms) is the fourth
generation than the first generation? Are you surprised by how quickly the population declines?
LO1
Feedback: Consider the following example. The current (first) generation consists of 1
million people, half of whom are women. Also assume that the total fertility rate is 1.3.
How big with the fourth generation be? To answer this question we first note that the
total fertility rate is the average number of children a woman is expected to have during
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2. A coal‐fired power plant can produce electricity at a variable cost of 4 cents per kilowatt hour
when running at its full capacity of 30 megawatts per hour, 16 cents per kilowatt hour when
running at 20 megawatts per hour, and 24 cents per kilowatt hour when running at 10 megawatts
per hour. A gas‐fired power plant can produce electricity at a variable cost of 12 cents per
kilowatt‐hour at any capacity from 1 megawatt per hour to its full capacity of 5 megawatts per
hour. The cost of constructing a coal‐fired plant is $50 million but it only costs $10 million to
build a gas‐fired plant. LO2
a. Consider a city that has a peak afternoon demand of 80 megawatts of electricity. If it wants all
plants to operate at full capacity, what combination of coal‐fired plants and gas‐fired plants would
minimize construction costs?
b. How much will the city spend on building that combination of plants?
c. What will the average cost per kilowatt‐hour be if you average over all 80 megawatts that are
produced by that combination of plants? (Hint: A kilowatt is one thousand watts while a
megawatt is one million watts).
d. What would the average cost per kilowatt‐hour be if the city had instead built three coal‐fired
plants?
Feedback: Consider the following example. A coal‐fired power plant can produce
electricity at a variable cost of 4 cents per kilowatt hour when running at its full capacity
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Parts a and b:
A city has a peak afternoon demand of 80 megawatts of electricity. If it wants all plants
to operate at full capacity, what combination of coal‐fired plants and gas‐fired plants
would minimize construction costs?
To operate at full capacity we have three choices. Choice 1: 2 coal-fired plants and 4 gas-
Part c:
What will the average cost per kilowatt‐hour be if you average over all 80 megawatts that
are produced by that combination of plants? (Hint: A kilowatt is one thousand watts
while a megawatt is one million watts).
To calculate the average cost per kilowatt hour we first recognize that 75% of our energy
Part d:
What would the average cost per kilowatt‐hour be if the city had instead built three
coal‐fired plants?
If the city built three coal-fired plants then two would operate at full capacity (30
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3. Suppose that Sea Shell oil company (SS) is pumping oil at a field off the coast of Nigeria. At
this site, it has an extraction cost of $30 per barrel for the first 10 million barrels it pumps each
year and then $60 per barrel for all subsequent barrels that it pumps each year, up to the site’s
maximum capacity of 90 million barrels per year. LO4
a. Suppose the user cost is $50 per barrel for all barrels and that the current market price for oil is
$90 per barrel. How many barrels will SS pump this year? What is the total accounting profit on
the total amount of oil it pumps? What is the total economic profit on those barrels of oil?
b. What if the current market price for oil rises to $120 per barrel while the user cost remains at
$50 per barrel? How many barrels will SS pump and what will be its accounting profit and its
economic profit?
c. If the current market price remains at $120 per barrel but the user cost rises to $95 per barrel,
how many barrels will SS pump this year and what will be its accounting profit and its economic
profit?
Feedback: Consider the following example. Suppose that Sea Shell oil company (SS) is
pumping oil at a field off the coast of Nigeria. At this site, it has an extraction cost of $30
per barrel for the first 10 million barrels it pumps each year and then $60 per barrel for all
subsequent barrels that it pumps each year, up to the site’s maximum capacity of 90
million barrels per year.
Part a:
Suppose the user cost is $50 per barrel for all barrels and that the current market price for
oil is $90 per barrel. How many barrels will SS pump this year? What is the total
accounting profit on the total amount of oil it pumps? What is the total economic profit
on those barrels of oil?
SS will pump only 10 million barrels. It will pump those 10 million because it is
Part b:
What if the current market price for oil rises to $120 per barrel while the user cost
remains at $50 per barrel? How many barrels will SS pump and what will be its
accounting profit and its economic profit?
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Part c:
If the current market price remains at $120 per barrel but the user cost rises to $95 per
barrel, how many barrels will SS pump this year and what will be its accounting profit
and its economic profit?
SS will pump zero barrels of oil this year as the total economic cost of pumping barrels
4. Eric and Kyle are fishermen with different equipment and, as a result, different costs for
catching fish. Eric’s costs for catching fish are $1000 per ton for the first five tons and then $2500
per ton for any additional tons. Kyle can harvest fish at a cost of $3000 for the first 15 tons and
then $1400 for any additional tons. LO5
a. If society wants 30 tons of fish and for some reason will only allow one of the two guys to do
all the fishing, which guy should society choose if it wants to minimize the cost of catching those
30 tons of fish? How much will the total cost of catching the fish be? What will the average
cost‐per‐ton be for the 30 tons?
b. If society wants 30 tons of fish and wants them for the least cost regardless of which guy is
catching them, how much should Eric and Kyle each catch? How much will the total cost of
catching 30 tons be? What will the average cost‐per‐ton be for the 30 tons?
c. Suppose that Eric and Kyle can both sell whatever amount of fish they catch for $3000 per ton.
Also suppose that Eric is initially given ITQs for 30 tons of fish while Kyle is given ITQs for zero
tons of fish. Suppose that Kyle is willing to pay Eric $550 per ton for as many tons of ITQs as
Eric is willing to sell to Kyle. How much profit would Eric make if he used all the ITQs himself?
What if Eric sold 25 tons’ worth of his ITQs to Kyle while using the other 5 tons of ITQs to fish
for himself?
d. What price per ton can Kyle offer to pay Eric for 25 tons of ITQs such that Eric would make
exactly as much money from that deal (in which he sells 25 tons’ worth of his ITQs to Kyle while
using the rest to fish for himself) as he would by using 30 tons of ITQs for himself?
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Feedback: Consider the following example. Eric’s costs for catching fish are $1000 per
ton for the first five tons and then $2500 per ton for any additional tons. Kyle can harvest
fish at a cost of $3000 for the first 15 tons and then $1400 for any additional tons.
Part a:
If society wants 30 tons of fish and for some reason will only allow one of the two guys
to do all the fishing, which guy should society choose if it wants to minimize the cost of
catching those 30 tons of fish? How much will the total cost of catching the fish be?
What will the average cost‐per‐ton be for the 30 tons?
The first step is to calculate the total cost of catching 30 tons of fish for both Eric and
Kyle.
Part b:
If society wants 30 tons of fish and wants them for the least cost regardless of which guy
is catching them, how much should Eric and Kyle each catch? How much will the total
cost of catching 30 tons be? What will the average cost‐per‐ton be for the 30 tons?
The first step is to recognize that Eric can catch the first 5 tons of fish at the lowest cost.
Thus, Eric will catch the first 5 tons of fish.
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Part c:
Suppose that Eric and Kyle can both sell whatever amount of fish they catch for $3000
per ton. Also suppose that Eric is initially given ITQs for 30 tons of fish while Kyle is
given ITQs for zero tons of fish. Suppose that Kyle is willing to pay Eric $550 per ton for
as many tons of ITQs as Eric is willing to sell to Kyle. How much profit would Eric make
if he used all the ITQs himself? What if Eric sold 25 tons’ worth of his ITQs to Kyle
while using the other 5 tons of ITQs to fish for himself?
If Eric harvested the 30 tons himself his revenue would be $90,000 (=$3000 x 30). The
total cost of harvesting 30 tons is $67,500 (see part a).
Part d:
What price per ton can Kyle offer to pay Eric for 25 tons of ITQs such that Eric would
make exactly as much money from that deal (in which he sells 25 tons’ worth of his ITQs
to Kyle while using the rest to fish for himself) as he would by using all the ITQs for
himself?
The profit per-ton Eric can make on his next 25 tons is $500 (= $3000 (sale price per ton)