Chapter I

Introduction
The concept of resources; resource scarcity and its economic implications; the economic process;
application of the concept.

THE CONCEPT OF RESOURCES

In broad terms, a resource can be defined as anything that is directly or indirectly capable of
satisfying human wants. Traditionally, economists classify resources into three broad categories:
labor, capital and natural resources. Labor encompasses the productive capacity of human
physical and/or mental efforts measured in terms of ability to do work or produce goods and
services. Examples are a worker on an auto assembly line, a high-school teacher and a
commercial truck driver. Capital refers to a class of resources that is produced for the purpose of
creating a more efficient production process. In other words, it is the stock of produced items
available not for direct consumption, but for further production purposes. Examples include
machines, buildings, computers and education (acquired skill). Natural resources are the stock of
living and nonliving materials found in the physical environment, and which have an identifiable
potential use to human beings (Randall 1987). Agricultural land, deposits of ferrous and
nonferrous minerals, water, fisheries, and wilderness and its multiple products are examples of
natural resources.
At this point, four key issues need to be clarified regarding this economic notion of resources.
First, it is rare that basic resources (labor, capital and natural resources) are used for direct
consumption without some modification. Resources are often used as factors of production or as
means to produce final goods and services that are capable of directly satisfying human needs. In
other words, basic resources are often viewed as a means to an end, rather than ends in
themselves. The second and somewhat related issue is that, the economic notion of resources is
strictly anthropocentric. That is, the economic value of any resource is defined by human needs
and nothing else—which implies that resources have no intrinsic value (value which depends
solely on the nature of the thing in question) (Attfield 1998). A case study has suggested that the
worthiness of a watershed service (water purification process by root systems and soil
microorganisms) is identified solely by its commercial value. The fact that the watershed under
consideration may have other, noneconomic value is not considered.
The third issue that needs to be understood is that each of the above resource categories is of
economic concern to the extent that they are scarce found in limited quantities and/or qualities.
The fourth issue deals with the fact that as factors of production, resources are used in
combinations. Furthermore, resources are generally considered to be fungible (Solow 1993). That
is, one kind of resource (such as a machine) can be freely replaced by another (such as labor) in
the production process; or one type of energy resource (such as petroleum) can be replaced by
another form of energy (such as natural gas). This is also evident in a case study, where it is
suggested that water purification for the city of New York can be undertaken either by investing
in the preservation of “natural capital” (a forest watershed) or by building a filtration plant—
physical capital. Fungibility implies that no particular resource is considered to be absolutely
essential for production of goods and services. However, as will be evident from the discussion
in the next section, fungibility does not in any way suggest an escape from the general problem
of resource scarcity.
 RESOURCE SCARCITY AND ITS ECONOMIC IMPLICATIONS
At the root of any economic study is the issue of resource scarcity. In fact, as a discipline,
economics is defined as the branch of social science that deals with the allocation of scarce
resources among competing ends. What exactly do economists mean by resource scarcity? What
are the broader implications of scarcity?
For economists, scarcity is the universal economic problem. Every human society, whether a
tribal society such as the Aborigines in Australia or an economically and technologically
advanced society such as Japan, is confronted with the basic problem of scarcity. That is, at any
point in time, given societal resource endowments and technological know-how, the total sum of
what people want to have (in terms of goods and services) is far greater than what they can have
(Kohler 1986). Considering that human wants for goods and services are immense and, worse
yet, insatiable in a world of scarcity, what can be done to maximize the set of goods and services
that people of a given society can have at a point in time? This question clearly suggests that the
significant economic problem involves rationing limited resources to satisfy human wants and,
accordingly, has the following four general implications:
1 Choice The most obvious implication of scarcity is the need to choose. That is, in a world of
scarcity, we cannot attain the satisfaction of all our material needs completely. Hence, we need to
make choices and set priorities.
2 Opportunity cost Every choice we make has a cost associated with it; one cannot get more of
something without giving up something else. In other words, an economic choice always entails
sacrifice or opportunity cost—the highest-valued alternative that must be sacrificed to attain
something or satisfy a want. In a world of scarcity, “there is no such thing as a free lunch.”
3 Efficiency In the presence of scarcity, no individual or society can afford to be wasteful or
inefficient. The objective is, therefore, to maximize the desired goods and services that can be
obtained from a given set of resources. This state of affairs is attained when resources are fully
utilized (full employment) and used for what they are best suited in terms of production (i.e.,
there is no misallocation of resources). Furthermore, efficiency implies that the best available
technology is being used (McConnell and Bruce 1996).
4 Social institutions As noted earlier, the essence of scarcity lies in the fact that people’s desire
for goods and services exceeds society’s ability to produce them at a point in time. In the
presence of scarcity, therefore, the allocation and distribution of resources always cause
conflicts. To resolve these conflicts in a systematic fashion, some kind of institutional
mechanism(s) needs to be established. For example, in many parts of the contemporary world,
the market system is used as the primary means of rationing scarce resources. How this system
operates conceptually is briefly discussed in the next section.

THE ECONOMIC PROCESS

In this section, using a circular flow diagram, an attempt will be made to specify the institutional
components that are basic to a market economy. As a working definition, an economy can be
viewed as a rather complex institutional mechanism designed to facilitate the production,
consumption and exchange of goods and services, given resource scarcity and technology, the
preferences of households, and the legal system for resource ownership rights (Randall 1987).
All economies are alike in the sense that they are devised to help facilitate the production,
consumption and exchange of goods and services, and they are constrained by resource scarcity
and technology. On the other hand, economies differ in the degree of empowerment given to
households and firms in their ability to make economic choices, and the legal view of property
ownership rights. For example, in a capitalistic and market-oriented economy, freedom of choice
and private ownership of property are strongly held institutional principles. In contrast, in a
centrally planned economy, the production and distribution of goods are dictated by bureaucratic
choices, with resource ownership retained by the state. The circular flow diagram in Figure 1 is
designed to show that the operation of a market-oriented economy is composed of the following
elements:
1 Economic entities (households and firms) Households are the final users of goods and services
and the owners of resources. In a market economy, given resource scarcity the primary goal is to
find effective ways to address the material needs of consumers (households). At least in
principle, consumers’ wellbeing is the primary goal of a market-oriented economy. Although
households are final users of goods and services, firms enter the economic process as
transformers of basic resources (labor, capital and natural resources) into goods and services, and
this is done on the basis of consumers’ preferences (demand).
2 Markets Markets represent an institutional arena in which exchanges (buying and selling) of
final goods and services and factors of production (labor, capital and natural resources) take
place. Traditionally, economists group markets into two broad categories, namely product and
factor markets. The product market is where the exchange of final goods and services occurs. In
this market, demand and supply provide information about households and firms, respectively.
The factor market refers exclusively to the buying and selling of basic resources, such as labor,
capital and natural resources. In this submarket, demand imparts market information about firms
and supply provides information about households. That is, households are the suppliers of labor,
capital and natural resources, while firms are the buyers, and in turn use these items to produce
final goods and services for the product market. Clearly, then, the roles played in the factor
market by households and firms respectively are the reverse of their roles in the product market.
In both the product and the factor markets, information about resource scarcity is transmitted
through prices. These prices are formed through the interactions of market demand and supply;
and, under certain conditions, market prices can be used as reliable indicators of both present and
future resource scarcities. Furthermore, using prices from the product market, economists
customarily measure aggregate economic performance of a given economy or a country by the
total market value of all the goods and services produced for final use within a given period,
usually a year. This is called gross domestic product (GDP) when the total market value of the
final goods and services produced is attributable to factors of production (labor, capital and
natural resources) originating exclusively from a given country (more on this in the next section).
3 Nonmarket public and private institutions A market does not function in a vacuum; that is, for
a market to operate efficiently, ownership rights need to be clearly defined and enforced. This
requires the establishment of public agencies designed to articulate and enforce the rules and
regulations by which ownership rights are attained, relinquished (transferred) and enforced. In
addition, competition in the marketplace is fostered through public intervention in some
instances. The public and private entities (social institutions) that legislate the rules for assigning
resource ownership rights and regulate the degree of competition in the marketplace are
represented by the box at the center of Figure 1. On one view, what flows from this box to
households, firms and markets is not physical goods but information services. In general, the
main function of these flows of information is to ensure that economic agents (households and
firms) are playing by some socially predetermined rules of the game. In this regard, ideally,
social institutions are perceived as being rather like a conductor of a symphony orchestra or a
traffic director at a busy intersection. Viewed this way, social institutions have important
economic functions. However, they should not be assumed to be either perfect or costless (North
1995). When they are not functioning well, the information communicated through them can
distort market signals (prices) and in so doing, significantly affect the allocation of scarce
resources.
It is important to note that these are from a purely neoclassical economic perspective. The next
section attempts to explore the implications of this type of “worldview” for resource concerns
and focuses on natural resources. Costa Rica is used as a case study, a nation whose recent
efforts to “preserve” its vital natural resources have been considerable (see Exhibit 1). This
exhibit, along with the discussions in the next section, further illustrates the anthropocentric
tendencies of the standard economic notions of natural resources, and resources in general.

Figure 1 Circular flow diagram of the economic process

EXHIBIT 1
ECOTOURISM, FORESTLAND PRESERVATION AND THE ECONOMY OF COSTA
RICA
Costa Rica, a small nation with a primarily agrarian economy, is well known for its wilderness
preserves. About 35 percent of the country’s total land area is covered with vast tracts of virgin
tropical forests. Much of this forestland supports a variety of trees, including rich stands of
ebony, balsa, mahogany, and cedar—which all have significant commercial value. The animal
population includes puma, jaguar, deer and monkeys.
Furthermore, Costa Rica’s forest is an important repository of many plants and biological species
with significant ecological, if not economic, values. It is reported that Costa Rica’s forest
ecosystem houses literally thousands of species of plants and animals. It is also important to note
that the forestland contains the watersheds that constantly replenish the many river tributaries
essential for providing one of the most critical energy resources of Costa Rica: waterpower.
The forest with its multiple products is important to the Costa Rican economy for more than its
obvious commercial values, and in recent years has been increasingly used for a specific type of
service: ecotourism. This entails preservation of a forest ecosystem to attract tourists interested in
having direct experience of or contact with nature. This development, among others, requires a
significantly different use of Costa Rica’s natural resources— preserving forestland for its
service value rather than the expansion of agricultural and cattle-ranching activities. In recent
years, Costa Rica has been regarded as the Mecca of ecotourism; and it is a major contributor to
Costa Rica’s fast-growing service sector. Currently, the service sector accounts for 58 percent of
Costa Rica’s GDP (World Resources Institute 1998), and between 1985 and 1995, Costa Rica’s
economy has grown at a healthy average annual rate of 4.5 percent.
Ecotourism is a relatively recent industry in Costa Rica. The recent push to ecotourism emerged
in large part from Costa Rica’s unsettling experience with deforestation in the previous two
decades. More specifically, during the 1970s and the early 1980s, Costa Rica attempted to
increase its economic diversity through an emphasis on livestock production. This economic
pursuit accelerated the rate of deforestation (Meyer 1993).
This trend has been contained, at least for now, and the switch from an emphasis on cattle
ranching to ecotourism can justifiably be considered a success. In this regard, Costa Rica seems
to have a new industry with the potential to create an economy consistent with sustainable use of
the country’s most important natural assets: the forestland and its multiple products.

APPLICATION OF THE CONCEPT: ECOTOURISM, CATTLE RANCHING AND THE

ECONOMY OF COSTA RICA
Figure 2 is a graphical depiction of a production possibility frontier (PPF). It shows all the
combinations of ecotourism services and cattle-ranching activities a society (in this case Costa
Rica) can produce, given resource scarcity, using the existing technology of production in both
the ecotourism and the cattle-ranching sectors of the economy. For example, Costa Rica can
produce amount E3 of ecotourism service if it chooses to use all its available resources to
specialize in the production of this service and nothing else. Ecotourism service may entail
conserving forestland for purposes such as bird-watching, nature appreciation and aesthetic
enjoyment, preserving animal and plant species for biological prospecting, game reserves, and so
on. Evidently, ecotourism is a natural resource-intensive industry, and its use as an example is
prompted by this factor alone. Similarly, R3 is the level of cattle-ranching activity that will be
taking place if, at a point in time, all Costa Rica’s available resources are used exclusively for
this purpose. These are, of course, two extreme cases. The most likely scenario is represented by
a mix of both economic activities. Using its available resources Costa Rica may choose to
produce amounts E1 and R2 of ecotourism and ranching activities, respectively.
What can we learn about choice, opportunity cost and efficiency using the notion of the PPF?
First, at a given point in time, we can view the production possibility curve as representing the
boundary line between the feasible and infeasible product choices of a society. For example, in
Figure 2, product (ecotourism service and cattle) combinations outside the PPF, such as M, are
unattainable. On the other hand, the feasible choices represent all the product combinations
inside the PPF, such as N, and all the points along the PPF curve. In this sense, although
resources are scarce, society is still confronted with an infinite number of feasible choices.
However, from a strictly economic viewpoint, there is a significant difference between output
choices lying inside the PPF curve and those that are located on the PPF curve. All product

Figure 2 The production possibility frontier for Costa Rica

combinations inside the PPF curve are regarded as inefficient. For example, point N is regarded
as inefficient because Costa Rica could instead, by using the same amount of resources, have
produced ecotourism services and cattle output combinations indicated by points A, B and C on
the PPF. In so doing, Costa Rica would have been able to produce more of either the ecotourism
service or cattle output (point C or A), or more of both products, as indicated by point B.
All output combinations along the PPF curve are regarded as efficient because, by definition,
each point represents a full utilization (full employment) of all the available scarce resources at a
point in time. Thus, there is no waste or idle resources. Society is still, however, confronted with
an infinite number of choices, and any choice along the production possibility curve entails an
opportunity cost. For example, in Figure 2, a move from A to C implies that to increase
ecotourism service from E1 to E2 Costa Rica has to reduce (sacrifice) its output of cattle from
R2 to R1. Thus, unless the country is using its scarce resources inefficiently (such as at point N),
economic choices always entail costs in terms of alternative opportunities forgone.
Furthermore, given the normal curvature of the PPF as presented in Figure 2, opportunity cost
increases as more and more scarce resources are devoted to further production of a specific
product. For example, if ecotourism service is further increased from E2 to E3, the opportunity
cost of doing this would suggest a drop of cattle production from R1 to zero. Clearly, this cost is
higher than the opportunity cost implied by an earlier move similar in magnitude when
ecotourism service was increased from E1 to E2. Why so? This is because the increase in
ecotourism is attained by the use of labor, capital and land that are progressively less suited to
this particular endeavor. The reason for this is that although resources (labor, capital and
natural resources) are generally fungible, they are not easily adaptable to alternative uses. In
other words, some resources are better suited for the production of some goods than they are for
other goods.
The case of Costa Rica illustrates increasing opportunity cost and its implication for resource
use. In 1970s and early 1980s Costa Rica was pursuing an aggressive economic policy intended
to expand its cattle ranching sector. One of the most notable effects of this policy was the rapid
transformation of forestland to pastureland. However, only 10 percent of Costa Rica’s land is
suitable for pastureland (Meyer 1993). Given this, continued expansion in cattle ranching could
be realized only at increasing opportunity cost; that is, at incrementally faster rates of
deforestation, which was the case during this period. Furthermore, Costa Rica’s deforestation
problem during this period was exacerbated by other economic and institutional factors. Among
others, these factors included (a) expanded use of marginal agricultural land to feed a rapidly
growing population; (b) distortion of market information by the government subsidies to cattle-
ranching operations; and (c) other institutional factors such as the land tenure system,
unwarranted growth of the government sector, and misallocation of resources due to growing
external debt.
What has been presented so far is a snapshot of a society’s alternative feasible and efficient
output choices. Furthermore, the set of feasible choices that faces a given society is subject to
change as technological advances occur. The effect of technological advances is depicted by an
outward shift of the PPF curve. In this way, technological change expands a society’s feasible
opportunity set. Several factors contribute to the expansion (growth) of the feasible combinations
of goods and services that a given society can produce. Major factors include a discovery of new
resources (such as a new oil deposit); an increase in the labor force; an increase in production
efficiency through factor substitutions; and an advance in technology representing an entirely
new production technique. It is through these sorts of change that a set that is infeasible at one
point in time, such as point M in Figure 2, could become feasible at some point in the future.
Technology fosters economic growth.
Last but not least, within this conceptual framework it is important to clearly understand the
difference between economic efficiency and optimality. Efficiency simply indicates that the
economy is operating on its production possibility curve; that is, resources are used to their full
potential. However, as demonstrated by the use of PPF, there is no one unique efficient point.
How, then, would society choose a point along its PPF—as it must at a particular point in time?
As briefly mentioned earlier, the neoclassical economic response to this question goes as
follows: The “optimal” (or best) point along a given PPF of a given country is ultimately
determined by the preferences of consumers (citizens). This in turn will determine the market
prices for final goods and services produced in an economy at a given point in time. Given these
prices, the optimal point along the production possibility frontier is that which yields the
maximum market value. Thus, for example, while points A and C are equally efficient, Costa
Rica may choose point A (less ecotourism and more cattle ranching) on the grounds that it is
associated with a higher level of market value or vice versa. This represents the core ideological
position of neoclassical economics; that is, ultimately what is “best” for a society is determined
by consumers’ preferences. At the same time, it also reflects the kind of value judgment
economists are making in choosing a single point along a given production possibility frontier
that theoretically contains an infinite set of efficient points.

Reference:
Ahmed , M. H., 2005. Principles of Environmental Economics –Economics, Ecology and
Public Policy, 3rded. Routledge , London and New York.