11. Markets for Capital and Natural Resources

1. 11. Markets for Capital and Natural Resources • Financial markets • Natural Resource markets

2. Financial Markets • Demand for financial capital • Supply of financial capital • interest rate • financial capital = loanable funds

3. Demand for Financial capital • firms demand funds to finance capital purchases • higher interest rate, more expensive to borrow • lower Q demanded of funds

4. interest rate D Q funds

5. Shifts in demand for funds • population growth • increase demand for goods, • increase demand for capital, • increase demand for funds

6. technology • increase demand for new capital, • increase demand for funds to finance it

7. Government borrowing • Federal gov’t deficits shift demand to the right

8. Supply of Financial capital • people’s savings decisions • tradeoff between consuming today & consuming tomorrow • Time preference • higher interest rates • encourage saving • higher opportunity cost of current consumption • higher Q supplied of funds

9. Shifts in supply of funds • population • higher population, more saving • supply shifts right • income • higher income, more savings • supply shifts right

10. expected future income • save today based on future needs -- retirement, college • save to smooth consumption over time • expect income to rise -- save less today, supply falls • expect income to fall -- save more today, supply rises

11. interest rate S i* D Q funds Q* Financial market equilbrium

12. Natural Resource markets • renewable resources • land, forests, livestock • nonrenewable resources • fossil fuels, metals

13. Market for land • supply is fixed for type or location • perfectly inelastic

14. rent S r* D Q land Q*

15. economic rent • rent for land is special • land is available even if rent=0 • demand affects P, not Q • economic rent • rent above what is required to induce Q supplied of factor

16. rent S economic rent r* D Q land Q*

17. Pure economic rent • Income earned by resource with a perfectly inelastic supply

18. Economic Rent • amount of resource earnings ABOVE opportunity cost • or resource earnings – minimum required earnings • “gravy”! “bonus”!

19. example: Shaquille O/Neal • 2000: $35 million • what is minimum for which he would play basketball and endorse stuff? • suppose $1 million • economic rent: $34 million

20. when do resources earn rent? • less elastic (more inelastic) the supply, • more rent as a % of total earnings

21. Differential rent • Rents earned to superior units of a resource • Where quality of resource affects productivity • Examples • Highly fertile farmland • Highly skilled trial lawyer

22. Inframarginal rent • Total rent when units of resource differ in their opportunity costs • What causes differences? • Differences in objectives • Differences in constraints

23. examples • Nursing • Find the work rewarding • Other constraints in the job market • Teaching summer school • Presence of small children • Children in college

24. P res. S P* D Q res. Q* upward-sloping supply earnings split rent opp. cost

25. Supply of nonrenewable resource • at point in time Q is fixed • but over time • use -- decrease supply • new discoveries -- increase supply • technology for better use -- decrease demand

26. example: metals • nonrenewable resource • discover new sources • use substitutes (plastic) • Recycling technology

27. Market-guided conservation • Markets have built-in incentives for efficient resource use • If a resource becomes scarce • Prices rise • Copper is up 50% in 2006

28. If prices rise • People use less (conserve) • People substitute • Firms look for new sources • Firms look for alternatives

29. Problems with markets & nonrenewable resources • Externalities • Extraction of oil, metals, natural gas have huge negative externalities • Market results in too much extraction • Government policies • Major tax breaks to domestic energy producers • Prices may not be sending the right signals

30. Doomsday scenarios • Aka • “We are running out of everything and we are all going to die”

31. Paul EhrlichThe Population Bomb, 1968 • "a major food shortage in the United States in the 1970s. . .hundreds of millions of people are going to starve to death." • By 1999 U.S. population would be only 23 million (actual 1999 U.S. population = 288 million)

32. Limits to Growth1974 World will run out of • gold by 1981 • mercury by 1985 • tin by 1987 • zinc by 1990 • petroleum by 1992, and • copper, lead, and natural gas by 1993

33. An economist’s refutation: • Julian Simon • The Ultimate Resource (1983) • Hoodwinking the Nation (1999) • Doomsayers underestimate human ingenuity

34. Simon vs. Ehrlich • Made a bet in 1980 for $1000 • Simon bet price of 5 key metals would be LOWER in 1990 • Signaling less scarcity • Simon won. Ehrlich paid • Simon offered to renew the bet, Ehrlich refused

36. Real concerns about resources today: • Has natural gas production peaked • Will oil production soon peak? Hubbert’s curve

37. Are we running out of copper? • Are we past the tipping point on global warming? BUT…. • Doomsayers need to take some responsibility for lack of world action