KEY VARIABLES AFFECTING THE SUPPLY OF A FACTOR OF PRODUCTION: THE CASE OF NATURAL RESOURCES

3.3 KEY VARIABLES AFFECTING THE SUPPLY OF A FACTOR OF PRODUCTION: THE CASE OF NATURAL RESOURCES

In a market-oriented economy, as discussed in Chapter 1 , factors of production are assumed to be owned by households (consumers). Households use factors of production as a means of generating income. This income is ultimately used to purchase final goods and services. Other things being equal, since more income means more final goods and services, it is in the best interest of households to fetch the highest possible price for the resources they own at a point in time. However, as we will see in the next section, the price that resource owners ultimately receive depends on both the demand for and the supply of the resource under consideration.

At this stage what we are interested in is to systematically identify the key variables affecting the supply for a factor of production, such as coal. To do this we first need to know what exactly the supply curve for a

38 MARKET SIGNALS OF SCARCITY

Figure 3.4 Market supply of coal

factor of production, such as the one shown in Figure 3.4 , tells us. One viable interpretation of the supply curve would be this: it is the locus of all possible minimum prices owners of coal mines are willing to accept for various amounts of coal offered in the market at a specified point in time. For example, to provide

amount C 1 of coal in the market, owners of coal would require a minimum price of r 1 . To the extent that the supply curve is assumed to be positively sloped, the minimum price that producers are willing to accept increases with an increase in quantity of coal supplied to the market. What justification can be offered to make this generalization valid?

We know that a resource such as coal has to be extracted from the ground and transported before it reaches the market. The immediate implication of this is that, in pricing coal, owners of coal mines need to account for the costs of extraction and transportation. At a minimum, owners of this resource will insist that the price they receive should cover the cost of extraction and transportation. It is for this reason that the minimum price owners of mines would require in order for them to sell a unit of coal should correspond to the cost of extracting and transporting that unit of coal. If we assume that transportation cost is negligible, a positively sloped supply curve for coal therefore implies that the extraction cost for coal is increasing. What could explain this?

One possible explanation for an increasing extraction cost of coal or any other extractive resource is that such resources are not uniformly distributed, spatially and/or in terms of quality or grade of ore (Brobst 1979). The conventional wisdom is that in a given mine, the high-grade coal is found first (Norgaard 1990). Gradually the grade tends to decline as extraction continues. Since the lower-grade coal requires further processing, other things being equal this will cause the cost of extraction to increase. Thus, according to this explanation, the rise in extraction cost has more to do with the limits imposed by nature than anything else (more on this in Chapter 17 ).

What remains in this section is to discuss the key factors affecting the supply of a natural resource, such as coal. In accordance with the neoclassical economic school, the factors affecting the supply of a natural resource can be divided into two broad categories—one pertaining to nature, and the other pertaining to technology.

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Most economists, if not all, agree that nature plays a role in determining the availability of natural resources. At the very least, nature puts an upper limit on the reproductive (regenerative) capacity of a particular resource. Furthermore, there seems to be a growing acceptance of the notion that the supply of certain resources is finite for the purpose of economic consideration, given that the regenerative capacity of some natural resources (such as coal) is measured on a geological timescale. Thus, by imposing upper limits to the supply of a particular natural resource, nature does “impose a particular scarcity.” In other words, the possibility of eventually exhausting a particular natural resource is real. Beyond this, however, the conventional wisdom in economic circles is that nature has only a minor role to play in determining the supply of natural resources (Barnett and Morse 1963). According to the prevailing economic view, therefore, the key factor that determines the supply of natural resources is technology.

Technology affects the supply of natural resources in a variety of ways. First, the supply of a natural resource could be enhanced through a technological improvement in the methods of resource extraction. An example of this would be the possibility of extracting a higher proportion of the useful minerals from a given rock containing some known concentration of ore. Second, the supply of a natural resource could be augmented by means of conservation through technological improvements. For example, the supply of coal could be effectively increased by means of energy-saving technology. Third, the supply of a natural resource will be affected whenever, by means of technological innovation, it is possible to find a substitute resource. For example, the supply of energy would be enhanced by a technology that significantly improved the economic feasibility of solar energy for direct use in both the residential and the industrial sectors. (More extensive discussion on factor substitution, technical change and their effects on natural resource availability is offered in Section 3.6 .) A careful observation of this last point suggests that if we are interested in the supply of energy, a narrow focus on what happens to the supply of a particular resource of energy (coal, petroleum, natural gas, nuclear, solar, geothermal, etc.) could be misleading and even dangerous. For a technological optimist, which most economists tend to be, running out of a particular natural resource would not represent a major concern (Solow 1974). The notion that “nature imposes a particular scarcity but not a general scarcity” is widely held among mainstream economists (Barnett and Morse 1963).