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Markets for Capital and Natural Resources

Financial markets Natural Resource markets

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Financial Markets

Demand for financial capital Supply of financial capital interest rate financial capital = loanable funds

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Demand for Financial capital

firms demand funds to finance capital purchases

higher interest rate, more expensive to borrow lower Q demanded of funds

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interest rate

Q funds

D

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Shifts in demand for funds

population growth increase demand for goods, increase demand for capital, increase demand for funds

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technology increase demand for new capital, increase demand for funds to finance it

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

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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

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Shifts in supply of funds

population higher population, more saving supply shifts right

income higher income, more savings supply shifts right

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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

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interest rate

Q funds

S

D

Financial market equilbrium

i*

Q*

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Natural Resource markets

renewable resources land, forests, livestock

nonrenewable resources fossil fuels, metals

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Market for land

supply is fixed for type or location perfectly inelastic

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Srent

Q land

D

r*

Q*

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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

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Srent

Q land

D

r*

Q*

economic rent

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Pure economic rent Income earned by resource with a perfectly

inelastic supply

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Economic Rent

amount of resource earnings ABOVE opportunity cost

or

resource earnings – minimum required earnings “gravy”! “bonus”!

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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

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when do resources earn rent?

less elastic (more inelastic) the supply, more rent as a % of total earnings

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Differential rent

Rents earned to superior units of a resource Where quality of resource affects productivity

Examples Highly fertile farmland Highly skilled trial lawyer

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Inframarginal rent

Total rent when units of resource differ in their opportunity costs

What causes differences? Differences in objectives Differences in constraints

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examples

Nursing Find the work rewarding Other constraints in the job market

Teaching summer school Presence of small children Children in college

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Q res.

P res.S

D

P*

Q*

upward-sloping supply

earnings split

rent

opp.cost

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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

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example: metals

nonrenewable resource discover new sources use substitutes (plastic) Recycling technology

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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

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

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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

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Doomsday scenarios

Aka “We are running out of everything and we are

all going to die”

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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)

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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

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An economist’s refutation:

Julian Simon The Ultimate Resource (1983) Hoodwinking the Nation (1999) Doomsayers underestimate human ingenuity

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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

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Real concerns about resources today:

Has natural gas production peaked Will oil production soon peak?

Hubbert’s curve

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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