Do markets underprice natural - resource commodities?

The author examines the efficiency and equity of a market allocation of exhaustible resources and assesses the behavior of scarcity measures, such as relative price and rental rates. She finds little evidence of scarcity or impending shortage. Indeed, the evidence points to falling prices and rents for many commodities. Do markets send the wrong signals? Are resource commodities systematically underpriced? Her conclusions are not completely optimistic. The authors analysis reveals many market failures, any of which would result in inappropriate resource commodity pricing. But,with one exception, she finds no systematic tendency to underprice. The exception concerns the environmental externalities associated with the production and use of natural-resource commodities. Similar externalities lead to underpricing and overuse of all commodities. Mineral commodities, however, are responsible for a large fraction of the pollution that is currently generated, so their underpricing is particularly significant. The market failures associated with common-property and environmental resources can cause market prices to be lower than shadow prices or marginal values. They cannot, however, cause relative resource prices to fall. Falling prices would be associated with a relaxation of environmental standards and a move away from full-social-cost pricing. The tendency, however, is towards increased awareness of environmental damage and increased willingness to pay for its associated costs. Nevertheless, the prices of many natural-resource commodities have fallen in real terms. Factors causing prices to decrease are not associated with market failure, and therefore do not support interference with the market mechanism. Innovations that lower mining and processing costs, discoveries that increase resource stocks, and the provision of lower-cost substitutes are all features of efficiently operating markets.