Resource Return on Investment under Markup Pricing

Kemp-Benedict, Eric (2013): Resource Return on Investment under Markup Pricing.

Abstract

In the (very) long run, a sustainable economy must rely on renewable resources. Until that time, an economy can be based on either renewable resources alone or a mix of renewable and non-renewable resources, but the particular mix may constrain the types of economic structures that are possible. A particularly important consideration is the quantity of resources required to extract the resources on which the economy is based, whether it is seeds retained for planting or petroleum used to extract oil. In the case of energy this is called “energy return on energy investment”, or EROI. More generally, it can be considered “resource return on resource investment”, or RROI. EROI has drawn attention lately both because the EROI of fossil fuels is falling and because the EROI of some renewable alternatives – especially for liquid fuels – is low compared to fossil fuels. In conventional economic analysis it is not clear what the relation between EROI, energy price, and macroeconomic outcomes might be. However, it raises immediate concerns within an Ecological Economic framework, in which resources – which may contribute only a small amount to GDP – are viewed as essential to the functioning of the economy. Resources are pictured as sitting at the base of an inverted pyramid, with the rest of the economy balanced on top of them. In this paper we show that when prices are set by markup, a standard Post-Keynesian assumption, then the “inverted pyramid” picture of the economy emerges naturally. We use this result to develop a computational framework for a “markup economy”, and apply it to the question of the macroeconomic impact of changes in resource prices and resource return on investment. We use the resulting model to explore several macroeconomic questions, demonstrating that the model is quite useful for exploring the role of natural resources in the macroeconomy. We then show our main result, that RROI has a surprisingly limited effect on real wages until it reaches quite low values.

• Item Type: MPRA Paper
• Language: English
• Keywords: EROI,macroeconomics,input-output,ecological economics,biophysical economics,Post Keynesian
• Subjects: E - Macroeconomics and Monetary Economics > E0 - General > E00 - General; E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E11 - Marxian ; Sraffian ; Kaleckian; E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E12 - Keynes ; Keynesian ; Post-Keynesian; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q0 - General > Q01 - Sustainable Development; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q4 - Energy > Q43 - Energy and the Macroeconomy

References

Ackerman, F. (2001) ‘Still dead after all these years: interpreting the failure of general equilibrium theory’. Journal of Economic Methodology, 9(2). 119–39. doi:10.1080/13501780210137083.

Armington, P. S. (1969) ‘A Theory of Demand for Products Distinguished by Place of Production’. Staff Papers-International Monetary Fund, 16(1). 159–78.

Arrow, K. J. (1974) ‘General Economic Equilibrium: Purpose, Analytic Techniques, Collective Choice’. The American Economic Review, 64(3). 253–72. doi:10.2307/1808881.

Ayres, R. U. and van den Bergh, J. C. J. M. (2005) ‘A theory of economic growth with material/energy resources and dematerialization: Interaction of three growth mechanisms’. Ecological Economics, 55(1). 96–118. doi:10.1016/j.ecolecon.2004.07.023.

Bak, P., Chen, K., Scheinkman, J. and Woodford, M. (1993) ‘Aggregate fluctuations from independent sectoral shocks: self-organized criticality in a model of production and inventory dynamics’. Ricerche Economiche, 47(1). 3–30. doi:10.1016/0035-5054(93)90023-V.

Bak, P., Tang, C. and Wiesenfeld, K. (1988) ‘Self-organized criticality’. Physical Review A, 38(1). 364–74. doi:10.1103/PhysRevA.38.364.

Blatt, J. M. (1983) Dynamic Economic Systems: a post-Keynesian Approach. M.E. Sharpe?; Wheatsheaf Books, Armonk, N.Y.?: Brighton, Sussex.

Blinder, A. S. (1998) Asking About Prices: a New Approach to Understanding Price Stickiness. Russell Sage Foundation.

Blinder, A. S. (1994) ‘On Sticky Prices: Academic Theories Meet the Real World’. Monetary Policy, N. G. Mankiw (ed.). University of Chicago Press, Chicago. 117–54.

Boccaletti, S., Latora, V., Moreno, Y., Chavez, M. and Hwang, D.-U. (2006) ‘Complex networks: Structure and dynamics’. Physics Reports, 424(4-5). 175–308. doi:10.1016/j.physrep.2005.10.009.

Bohi, D. R. (1991) ‘On the macroeconomic effects of energy price shocks’. Resources and Energy, 13(2). 145–62. doi:10.1016/0165-0572(91)90012-R.

Bonfrer, A. and Chintagunta, P. (2004) ‘Store Brands: Who Buys Them and What Happens to Retail Prices When They Are Introduced?’ Review of Industrial Organization, 24(2). 195–218. doi:10.1023/B:REIO.0000033352.19694.4a.

Chintagunta, P. K. (1993) ‘Investigating Purchase Incidence, Brand Choice and Purchase Quantity Decisions of Households’. Marketing Science, 12(2). 184–208.

Cleveland, C. (2010) ‘Biophysical economics’. Encyclopedia of Earth. http://www.eoearth.org/view/article/150665/.

Cleveland, C. J. (2005) ‘Net energy from the extraction of oil and gas in the United States’. Energy, 30(5). 769–82. doi:10.1016/j.energy.2004.05.023.

Cleveland, C. J., Costanza, R., Hall, C. A. S. and Kaufmann, R. (1984) ‘Energy and the U.S. Economy: A Biophysical Perspective’. Science, 225(4665). 890–97. doi:10.2307/1693932.

Cleveland, C. J., Kaufmann, R. K. and Stern, D. I. (2000) ‘Aggregation and the role of energy in the economy’. Ecological Economics, 32(2). 301–17. doi:10.1016/S0921-8009(99)00113-5.

Cleveland, C. J. and Ruth, M. (1998) ‘Indicators of Dematerialization and the Materials Intensity of Use’. Journal of Industrial Ecology, 2(3). 15–50. doi:10.1162/jiec.1998.2.3.15.

Curry, D. J. and Riesz, P. C. (1988) ‘Prices and Price/Quality Relationships: A Longitudinal Analysis’. Journal of Marketing, 52(1). 36–51. doi:10.2307/1251684.

Curtis, F. (2009) ‘Peak globalization: Climate change, oil depletion and global trade’. Ecological Economics, 69(2). 427–34. doi:10.1016/j.ecolecon.2009.08.020.

Daly, H. (2013) ‘A further critique of growth economics’. Ecological Economics, 88. 20–24. doi:10.1016/j.ecolecon.2013.01.007.

Daly, H. E. (1995) ‘Consumption and Welfare: Two Views of Value Added’. Review of Social Economy, 53(4). 451–73. doi:10.2307/29769815.

Debreu, G. (1959) Theory of Value: An Axiomatic Analysis of Economic Equilibrium. Cowles Foundation for Research in Economics at Yale University. Monograph. Yale University Press, New Haven.

Dicken, P. (2011) Global Shift: Mapping the Changing Contours of the World Economy. 6th ed. SAGE Publications Ltd, Los Angeles, CA, US.

Earl, P. and Wakeley, T. (2010) ‘Alternative perspectives on connections in economic systems’. Journal of Evolutionary Economics, 20(2). 163–83. doi:10.1007/s00191-009-0147-7.

Evans, L. T. (1980) ‘The Natural History of Crop Yield: A combination of improved varieties of crop plants and technological innovations continues to increase productivity, but the highest yields are approaching limits set by biological constraints’. American Scientist, 68(4). 388–97. doi:10.2307/27849950.

Fagerberg, J. (2003) ‘Schumpeter and the revival of evolutionary economics: an appraisal of the literature’. Journal of Evolutionary Economics, 13(2). 125–59. doi:10.1007/s00191-003-0144-1.

Fagnart, J.-F. and Germain, M. (2011) ‘Quantitative versus qualitative growth with recyclable resource’. Ecological Economics, 70(5). 929–41. doi:10.1016/j.ecolecon.2010.11.008.

Federal Reserve Bank of St. Louis (2013) ‘Federal Reserve Economic Data - FRED - St. Louis Fed’. http://research.stlouisfed.org/fred2/.

Foster, J. (2005) ‘From simplistic to complex systems in economics’. Cambridge Journal of Economics, 29(6). 873–92. doi:10.1093/cje/bei083.

Gagnon, N., Hall, C. A. S. and Brinker, L. (2009) ‘A Preliminary Investigation of Energy Return on Energy Investment for Global Oil and Gas Production’. Energies, 2(3). 490–503. doi:10.3390/en20300490.

Galbraith, J. K. (2007) The New Industrial State. Princeton University Press.

Georgescu-Roegen, N. (1975) ‘Energy and Economic Myths’. Southern Economic Journal, 41(3). 347–81. doi:10.2307/1056148.

Gerstner, E. (1985) ‘Do Higher Prices Signal Higher Quality?’ Journal of Marketing Research, 22(2). 209–15. doi:10.2307/3151366.

Goldemberg, J. (2007) ‘Ethanol for a Sustainable Energy Future’. Science, 315(5813). 808–10. doi:10.1126/science.1137013.

Gordon, R. J. (1999) ‘U.S. Economic Growth since 1870: One Big Wave?’ The American Economic Review, 89(2). 123–28. doi:10.2307/117092.

Gowdy, J. M. (1991) ‘Bioeconomics and post Keynesian economics: a search for common ground’. Ecological Economics, 3(1). 77–87. doi:10.1016/0921-8009(91)90049-K.

Greenhouse, S. (2013) ‘America’s Productivity Climbs, but Wages Stagnate’. The New York Times, 12 January. Sunday Review. http://www.nytimes.com/2013/01/13/sunday-review/americas-productivity-climbs-but-wages-stagnate.html.

Guilford, M. C., Hall, C. A. S., O’Connor, P. and Cleveland, C. J. (2011) ‘A New Long Term Assessment of Energy Return on Investment (EROI) for U.S. Oil and Gas Discovery and Production’. Sustainability, 3(12). 1866–87. doi:10.3390/su3101866.

Hall, C. A. S., Balogh, S. and Murphy, D. J. R. (2009) ‘What is the Minimum EROI that a Sustainable Society Must Have?’ Energies, 2(1). 25–47. doi:10.3390/en20100025.

Hall, R. E. (1988) ‘The Relation between Price and Marginal Cost in U.S. Industry’. Journal of Political Economy, 96(5). 921–47. doi:10.2307/1837241.

Hall, R. L. and Hitch, C. J. (1939) ‘Price Theory and Business Behaviour’. Oxford Economic Papers, (2). 12–45. doi:10.2307/2663449.

Hamilton, J. D. (2008) ‘Oil and the Macroeconomy’S. N. Durlauf and L. E. Blume (eds.). The New Palgrave Dictionary of Economics. http://www.dictionaryofeconomics.com/extract?id=pde2008_E000233.

Hammerschlag, R. (2006) ‘Ethanol’s Energy Return on Investment:? A Survey of the Literature 1990-Present’. Environmental Science & Technology, 40(6). 1744–50. doi:10.1021/es052024h.

Han, S., Gupta, S. and Lehmann, D. R. (2001) ‘Consumer price sensitivity and price thresholds’. Journal of Retailing, 77(4). 435–56. doi:10.1016/S0022-4359(01)00057-4.

Heaps, C., Erickson, P., Kartha, S. and Kemp-Benedict, E. (2009) Europe’s Share of the Climate Challenge: Domestic Actions and International Obligations to Protect the Planet. Stockholm Environment Institute, Stockholm.

Hoderlein, S. (2011) ‘How many consumers are rational?’ Journal of Econometrics, 164(2). 294–309. doi:10.1016/j.jeconom.2011.06.015.

Holt, R. P. F. and Pressman, S. (2001) ‘What is Post Keynesian Economics?’ A new guide to post Keynesian economics, R. P. F. Holt and S. Pressman (eds.). Contemporary political economy series. Routledge, London?; New York. 1–10.

Hong, B. H., Lee, K. E. and Lee, J. W. (2007) ‘Power law in firms bankruptcy’. Physics Letters A, 361(1–2). 6–8. doi:10.1016/j.physleta.2006.09.034.

Joffe, M. (2011) ‘The root cause of economic growth under capitalism’. Cambridge Journal of Economics, 35(5). 873–96. doi:10.1093/cje/beq054.

Jones, D. W., Paik, I. K. and Leiby, P. N. (2004) ‘Oil Price Shocks and the Macroeconomy: What Has Been Learned Since 1996’. The Energy Journal, 25(2). doi:10.5547/ISSN0195-6574-EJ-Vol25-No2-1.

Judson, D. H. (1989) ‘The convergence of neo-Ricardian and embodied energy theories of value and price’. Ecological Economics, 1(3). 261–81. doi:10.1016/0921-8009(89)90009-8.

Kalecki, M. (1969) Theory of Economic Dynamics: An Essay on Cyclical and Lon-run Changes in Capitalist Economy. Augustus M. Kelly, New York, NY, US.

Kalecki, M. (1939) ‘Money and real wages’. Collected Works of Michal Kalecki, 2. 21–50.

Kapeller, J., Schütz, B. and Steinerberger, S. (2012) ‘The impossibility of rational consumer choice’. Journal of Evolutionary Economics, . 1–22. doi:10.1007/s00191-012-0268-2.

Kaufmann, R. K. (1994) ‘The relation between marginal product and price in US energy markets: Implications for climate change policy’. Energy Economics, 16(2). 145–58. doi:10.1016/0140-9883(94)90009-4.

Keane, M. P. and Prasad, E. S. (1996) ‘The Employment and Wage Effects of Oil Price Changes: A Sectoral Analysis’. The Review of Economics and Statistics, 78(3). 389–400. doi:10.2307/2109786.

Keen, S. (2003) ‘Standing on the toes of pygmies:: Why econophysics must be careful of the economic foundations on which it builds’. Physica A: Statistical Mechanics and its Applications, 324(1–2). 108–16. doi:10.1016/S0378-4371(02)01851-4.

Kemp-Benedict, E., Kartha, S. and Fencl, A. (2012) Biomass in a Low-Carbon Economy: Resource Scarcity, Climate Change, and Business in a Finite World. SEI Project Report. Stockholm Environment Institute, Stockholm Sweden. http://www.sei-international.org/publications?pid=2078.

Kirman, A. (1989) ‘The Intrinsic Limits of Modern Economic Theory: The Emperor has No Clothes’. The Economic Journal, 99(395). 126–39. doi:10.2307/2234075.

Kreith, F. (2012) ‘Bang for the buck: energy return on energy investment is a powerful metric for weighing which energy systems are worth pursuing’. Mechanical Engineering-CIME, 134(5). 26–31.

Kronenberg, T. (2010) ‘Finding common ground between ecological economics and post-Keynesian economics’. Ecological Economics, 69(7). 1488–94. doi:10.1016/j.ecolecon.2010.03.002.

Lancaster, K. J. (1966) ‘A New Approach to Consumer Theory’. Journal of Political Economy, 74(2). 132–57.

Lavoie, M. (2004) ‘Post Keynesian consumer theory: Potential synergies with consumer research and economic psychology’. Journal of Economic Psychology, 25(5). 639–49. doi:10.1016/j.joep.2003.02.001.

Lavoie, M. (2001) ‘Pricing’. A new guide to post Keynesian economics, R. P. F. Holt and S. Pressman (eds.). Contemporary political economy series. Routledge, London?; New York.

Li, G., Yang, H., Sun, L., Ji, P. and Feng, L. (2010) ‘The evolutionary complexity of complex adaptive supply networks: A simulation and case study’. International Journal of Production Economics, 124(2). 310–30. doi:10.1016/j.ijpe.2009.11.027.

Loasby, B. J. (2001) ‘Cognition, imagination and institutions in demand creation’. Journal of Evolutionary Economics, 11(1). 7–21. doi:10.1007/PL00003857.

Loecker, J. D. and Warzynski, F. (2009) Markups and Firm-level Export Status. 15198. National Bureau of Economic Research. http://www.nber.org/papers/w15198.

Mathieu, K.-H. (1993) ‘Bioeconomics and post Keynesian economics: a search for common ground’. Ecological Economics, 8(1). 11–16. doi:10.1016/0921-8009(93)90028-5.

Minsky, H. P. (2008) Stabilizing an Unstable Economy. McGraw-Hill, New York, NY [u.a.

Mitra-Kahn, B. H. (2008) Debunking the Myths of Computable General Equilibrium Models. SCEPA Working Paper, 2008-1. The New School for Social Research, New York, NY, US. http://www.newschool.edu/scepa/publications/workingpapers/SCEPA%20Working%20Paper%202008-1%20Kahn.pdf.

Murphy, D. J. and Hall, C. A. S. (2011) ‘Energy return on investment, peak oil, and the end of economic growth’. Annals of the New York Academy of Sciences, 1219(1). 52–72. doi:10.1111/j.1749-6632.2010.05940.x.

Murphy, D. J. and Hall, C. A. S. (2010) ‘Year in review—EROI or energy return on (energy) invested’. Annals of the New York Academy of Sciences, 1185(1). 102–18. doi:10.1111/j.1749-6632.2009.05282.x.

Praetorius, B. and Schumacher, K. (2009) ‘Greenhouse gas mitigation in a carbon constrained world: The role of carbon capture and storage’. Energy Policy, 37(12). 5081–93. doi:10.1016/j.enpol.2009.07.018.

Rasche, R. H. and Tatom, J. A. (1977) ‘Energy resources and potential GNP’. Review, (Jun). 10–24.

Rockström, J. and Karlberg, L. (2010) ‘The Quadruple Squeeze: Defining the safe operating space for freshwater use to achieve a triply green revolution in the Anthropocene’. AMBIO, 39(3). 257–65. doi:10.1007/s13280-010-0033-4.

Safarzynska, K. and van den Bergh, J. C. J. M. (2010) ‘Evolutionary models in economics: a survey of methods and building blocks’. Journal of Evolutionary Economics, 20(3). 329–73. doi:10.1007/s00191-009-0153-9.

Sayama, H., Pestov, I., Schmidt, J., Bush, B. J., Wong, C., Yamanoi, J. and Gross, T. (2013) ‘Modeling complex systems with adaptive networks’. Computers & Mathematics with Applications, . doi:10.1016/j.camwa.2012.12.005.

Scheinkman, J. A. and Woodford, M. (1994) ‘Self-Organized Criticality and Economic Fluctuations’. The American Economic Review, 84(2). 417–21. doi:10.2307/2117870.

Schellnhuber, H. J., Hare, B., Serdeczny, O., Svirejeva-Hopkins, A., Schwan, S., et al. (2013) Turn down the Heat?: Climate Extremes, Regional Impacts, and the Case for Resilience - Executive Summary. 78422. The World Bank. http://documents.worldbank.org/curated/en/2013/06/17861350/turn-down-heat-climate-extremes-regional-impacts-case-resilience-executive-summary.

Schenk, K.-E. (2006) ‘Complexity of economic structures and emergent properties’. Journal of Evolutionary Economics, 16(3). 231–53. doi:10.1007/s00191-005-0003-3.

Simon, H. A. (1984) ‘On the behavioral and rational foundations of economic dynamics’. Journal of Economic Behavior & Organization, 5(1). 35–55. doi:10.1016/0167-2681(84)90025-8.

Sippel, R. (1997) ‘An Experiment on the Pure Theory of Consumer’s Behaviour*’. The Economic Journal, 107(444). 1431–44. doi:10.1111/j.1468-0297.1997.tb00056.x.

Smiley, R. A. and Jackson, H. L. (2002) Chemistry and the Chemical Industry: A Practical Guide for Non-Chemists. CRC Press, Boca Raton.

Sraffa, P. (1960) Production of Commodities by Means of Commodities: Prelude to a Critique of Economic Theory. Indian Edition 1963. Vora & Co., Bombay, India.

Strotz, R. H. (1957) ‘The Empirical Implications of a Utility Tree’. Econometrica, 25(2). 269–80. doi:10.2307/1910254.

Taylor, L. (2004) Reconstructing Macroeconomics Structuralist Proposals and Critiques of the Mainstream. Harvard University Press, Cambridge, Mass.

US BLS (2013) ‘Industry Labor Productivity and Costs’. Bureau of Labor Statistics Current Population Survey, 29 May. http://www.bls.gov/cps.

US EIA (2012) Annual Energy Review 2011. DOE/EIA-0384(2011). U.S. Energy Information Administration (EIA), Washington, D.C., US.

Wu, H. (2009) ‘Entry barriers and markup ratios: evidence from OECD countries’. Applied Economics Letters, 16(2). 125–30. doi:10.1080/13504850601018122.