Natural Resource Economics:An Overview

2 period model

MUC rises at rate of discount In period 2, MUC 1+r as large as in period 1 Suggests that efficiency involves rising MUC

and falling Q Generalize to longer time periods

MUC

In order for an owner of resource to be indifferent as to the period in which they sell, PV of the MUC must be the same in all periods.

This means that MUC of an exhaustible resource will increase with the discount rate.

price equation

efficiency pricing:

Pt = MECt + MUCt

whereMEC refers to Marginal Extraction CostMUC refers to Marginal User Cost

MUC and MEC

The existence of MUC means that price will always be different from MEC.

MUC = P – MEC (net benefit) MUC is a form of scarcity rent If no scarcity, MUC = 0 If scarcity, MUC = PV of marginal net benefit in each

time period If MEC = 0

Competitive firm MUC = price = MB Monopoly MUC = MR = MB

social planner vs. monopolist

how does allocation differ with respect to planner?

“social planner”: maximize net benefit to society

monopoly: maximize profit (producer surplus)

excel example:dynamically efficient extraction of an exhaustible resource

100 tons of coal 2 periods MEC = 0 Demand each period P = 500 – 0.5q How will 100 tons be allocated over 2

periods?

2 ways to analyze

1. maximize social welfare (“benevolent social planner”): CS + PS

2. maximize PS: monopolist maxes PV profit

using excel solver

enter equations enter parameters specify changing cells specify objective cell

constant MEC with no substitute

MUC and Q over time

efficient MUC rises, reflecting increasing scarcity

in response, quantity extracted falls over time until reaching zero, when total MC = highest WTP

efficiency requires smooth transition to exhaustion of resource

transition to a renewable substitute

backstop resource, available at constant MEC (e.g., solar)

when is it efficient to switch to backstop?

when cheaper to do so!

with no backstop, max WTP (“choke price”) sets limit on total MC

backstop’s MEC now sets upper limit

switch point

prior to switch point, exhaustible resource is cheaper

at the switch point, MC of exhaustible resource (including MUC) rises to meet MC of substitute

consumption of renewable begins

exploration and discovery

expensive as more easily discovered resources are

exhausted, search is less hospitable environs (bottom of ocean, deep within earth)

MC of exploration will rise over time