Economics Theory In Non Renewable Resource Economics Essay

Basically, renewable resource is defined as the resource that is replaceable of course or by human activity. Examples of renewable resources include air, carnal populations, groundwater, etc. In other manus, non-renewable resources are non replaceable, or the rate of reproduce is so slow by natural or unreal procedures that for all practical intents, one time used they would non be available once more within short period. The obvious illustration is crude oil.

Economicss is a sub-social scientific discipline that focuses on the allotment of the limited resources in order to accomplish highest returns. Since non-renewable resources non merely a fixed stock, and besides limited in supply comparative to the demand for them. Hence, some slow-growing resources, like crude oil and mineral sedimentations, possibly categorized as non-renewable in economic sciences. They may besides be ecologically alone and non consistent. Similarly, while coal would be considered non-renewable by some, most resource economic experts would see it renewable due to the tremendous staying stock.

Traditionally, the major economic issues studied in non-renewable resources involve foretelling the hereafter production and monetary value flights, every bit good as the day of the month of possible resource exhaustion ( that is the ground why, we have to analyze resources extraction program in university ) . In add-on, there has been an attempt to understand the impact of assorted market constructions, such as competition, monopolistic, and oligopoly, on the predicted flights. The consideration of this issue is because of construction of house will impact the operation of house, and so this operation will, finally, affects its public presentation and the society ( or environment ) .

Resource Depletion with The Hotelling Model

Let ‘s back to the really basic economic sciences objective is that the allotment of limited resources while the demand is limitless. The cardinal inquiry in non-renewable resource economic sciences is similar with the basic economic sciences nonsubjective: given consumer demand and the initial stock of the resource, how much should be harvested in each period, so as to maximise net incomes? A simple illustration brings out the underlying intuition. The premise made merely on the monetary value per unit, P, of the resource in the market. Assume besides that the existent ( rising prices adjusted ) , riskless involvement rate on investings in the economic system is r per cent per twelvemonth. Then, the proprietor of the resource can either pull out the resource now or keep on to it to pull out in the hereafter. Any sum of the resource extracted today will non be available in the hereafter, and any resource left untasted today may bring a higher monetary value in the market in the hereafter. In short, the extraction determination is fundamentally based on the alterations of existent involvement rate and value of the resources. If the proprietor extracts the resource today she can put the returns and earn R per cent twelvemonth. However, if she expects the monetary value of the resource to lift faster than r per cent per twelvemonth, so it would do sense to keep on to the resource, waive the involvement earned on the returns but earn a higher entire income by selling the resource at a higher monetary value per unit. The opposite statement would keep if the resource monetary value was expected to lift slower than R per cent per twelvemonth ( Hotelling, 1931 ; Neha khanna, 2003 )

Harmonizing to Neha Khanna in a competitory market where there are a big figure of Sellerss, and each marketer can sell any measure at the given market monetary value, each resource proprietor would be faced with the same options. The theoretical consequence is that in this market the measure extracted will be such that resource monetary value will lift at precisely r per cent per twelvemonth. If monetary values were to lift slower, resource proprietors would get down to sell off current stocks and the current market monetary value would fall. If the resource monetary value were to increase at a rate faster than r per cent per twelvemonth, all proprietors of the resource would keep on to their stock, diminishing the current supply in the market, thereby bring oning the current market monetary value to lift. The equilibrium monetary value flight for a non-renewable resource would, hence, be lifting exponentially as shown in Figure 1, where P0 is the initial monetary value and T indicates the clip period of resource exhaustion.

An deduction of the continuously rising monetary value is that the measure extracted ( supply ) would be continuously falling until such clip as the resource is exhausted. As the monetary value rises the demand for the resource is easy choked off. Finally the monetary value would be so high that demand would be eliminated wholly. In the basic theoretical account, this is exactly when the resource stock would besides be wholly exhausted. To understand why, suppose that when the monetary value is sufficiently high to barricade off wholly all the demand, resource proprietors are left with some positive measure of the resource. This staying stock would be wholly worthless to the proprietor since no 1 would desire to purchase it. Recognizing this, the resource proprietors would get down to sell off the stock at lower monetary values before the demand is block off by the high monetary values. However, this would intend that there would be an extra supply of the resource in the market which would take down current monetary values. The production flight would be extended in clip and once more the monetary value would go on to lift at R per centum per twelvemonth until all the stock is wholly depleted. The equilibrium production ( or extraction ) flight for a non-renewable resource for a non-renewable resource is besides shown in figure 1.

Figure 1: Equilibrium Price and Quantity Trajectories for a Non-Renewable Resource

This basic consequence that the monetary value of a non-renewable resource in a competitory market would lift at the involvement rate and that the production flight would be monotonically worsening till the resource is exhausted.

It can be shown that by following the above production trajectory the resource proprietor maximizes the present value of the flow of grosss from extraction over the clip frame from the present through the exhaustion of the resource. It can besides be shown that the same production flight maximizes the discounted amount of manufacturers ‘ and consumers ‘ excess in a competitory market and is, hence, Pareto optimal.

Hotelling Model

The Cost of Extraction

Suppose that the fringy extraction cost is easy lifting over clip. This could be because a larger measure of resources is being extracted in each period or due to more rigorous environmental policies necessitating more expensive extraction techniques, or both. Whatever the ground, so long as the fringy extraction cost is non determined straight by the cumulative sum of the resource extracted, the consequence would be that net monetary value, i.e. , monetary value minus the fringy extraction cost, or scarceness rent, would lift exponentially at R per cent per twelvemonth ( Neha Khanna, 2003 ) .

However, though Hotelling ‘s theoretical account of resource depletion implies that net monetary value would be lifting exponentially at the involvement rate, this does non intend that the market monetary value ( i.e. , the monetary value paid by the consumer ) will follow this flight. The consumer monetary value is the fringy extraction cost plus the scarceness rent[ 1 ]. If extraction costs are falling, say due to technological betterments as in the instance of the oil industry during the last decennaries of the 20th century, so it is wholly possible that the market monetary value is changeless or even worsening in the close term. So long as the downward force per unit area due to the falling fringy extraction cost outweighs the lifting scarceness rent, the consumer monetary value will be diminishing. Finally, nevertheless, as the resource gets depleted and the scarceness rent rises quickly and outweighs the fringy cost, the market monetary value will lift.

When the fringy extraction cost is lifting over clip, the equilibrium production flight is monotonically worsening, as in the simple instance with no extraction cost. However, if the fringy extraction cost lessenings with clip, so it is besides possible for the equilibrium measure flight to increase in the close term. During this period, the downward force per unit area of the falling fringy cost more than beginnings the lifting user cost.

To bring forth Insight that illuminate our standing today.

The Cost of Reserve Dependent

Besides that, theory of non-renewable resource depletion would associate the fringy extraction cost straight will conglomerate production or the staying stock of the resource. These are referred to as “ modesty dependant costs ” in the literature. In this instance, each unit of the resource extracted today is non merely unavailable in the following period, but besides increases future extraction costs by take downing the staying militias. The chance or user cost of pull outing a finite stock of resources is now double: foregone involvement income and higher extraction costs. In this instance, the scarceness rent does non lift at the involvement rate, but at the involvement rate less the per centum addition in cost due to a fringy decrease in staying militias ( Neha Khanna, 2003 ) .

Note that the basic rule remains integral: at equilibrium, the fringy benefit from extraction must be the fringy economic cost ( defined as the amount of fringy extraction cost and the user cost ) . In the instance with no or changeless extraction costs, or with extraction costs that vary independently of cumulative production, the economic cost of extraction is merely the foregone involvement income. With reserve dependant costs, one must include the addition in fringy extraction cost that occurs as staying militias are drawn down by current extraction.


The cardinal consequences of the Hotelling theoretical account remain unchanged when the full stock of the resource is owned by a individual marketer. In this instance it is the fringy net income or the difference between the fringy gross and fringy extraction cost that grows at R per cent per twelvemonth. However, if in the presence of a inactive demand curve the monetary value snap of demand lessenings as the measure extracted additions, the monopolizer ‘s production flight will be longer than that of the competitory resource proprietor when faced with indistinguishable costs, initial stock, and consumer demand. The monopolizer takes advantage of the comparatively lower monetary value snap in the earlier periods to curtail end product and bear down a higher monetary value than the absolutely competitory resource proprietor. The consequence is that the extraction way tends to acquire stretched out over clip – that is, monopoly slows the depletion rate. This consequence has led to the proverb, “ a monopolizer is a environmentalist ‘s best friend ” ( Conrad, 1999 ) . The monopolistic and competitory monetary value and measure flights are compared in Figure 2, where Tc and Tm indicate exhaustion under competition and monopoly, severally.

Figure 2: Monopoly V. Competitive Equilibrium Price and Quantity Trajectories

One instance where the competitory and monopoly equilibrium monetary value and extraction waies are indistinguishable is when the resource proprietors face a changeless snap demand curve that is unchanging over clip, and when the extraction cost is independent of the measure extracted in each period. The important characteristic of a changeless snap demand curve, as opposed, say, to a additive demand curve, is that entire gross is the same at all points on the curve. No affair how much the monopolizer raises the monetary value of the resource, measure demanded diminutions proportionally so that entire gross is changeless. In this instance, the monopolizer can non increase the present value of net incomes by curtailing measure and raising monetary value in the earlier periods.

The World Oil Issue

In the 1980s ecologist Paul Ehlrich and economic expert Julian Simon were engaged in a het argument, and even a stake, on whether non-renewable resources were going scarcer, and whether their monetary values would lift as predicted by the Hotelling theoretical account. In 1990, Ehlrich lost the stake. The inflation-adjusted monetary values of five antecedently agreed upon non-renewable resources – Cu, chrome, Ni, Sn, and tungsten – fell over the class of the decennary. ( Neha Khanna, 2003 )

Even though Julian Simon won that stake and argument, it does non follow that worsening monetary values are inconsistent with a resource-depletion theoretical account. The anticipation that monetary value would lift monotonically while measure lessenings is typically obtained under the premises that, over clip, demand is changeless, and fringy cost of extraction rises. An alternate version of the theoretical account can give monetary value and measure flights that are much more consistent with the ascertained informations.

To appreciate the power and versatility of the Hotelling theoretical account, see the planetary oil market. There has been much argument over when the universe will make exhaustion of conventional crude oil resources. In the 1970s, following the first oil daze, some economic experts predicted that planetary oil supply would worsen and that depletion would happen in the close hereafter. Presented below are simulations based on an extension of the Hotelling theoretical account that incorporates the increasing demand for oil due to the growing in universe population and per capita income. In add-on, the theoretical account allows for fringy extraction cost to alter over clip ( addition or lessening ) , though independently of staying oil stocks ( i.e. , extraction costs are non reserve-dependent ) . The price reduction rate is assumed to be five per cent per twelvemonth, and staying oil militias are fixed at 2.1 trillion barrels. Six different scenarios are considered. In the base instance, universe demand is turning at approximately two per cent per twelvemonth and the fringy cost of extraction grows at around 1.6 per cent per twelvemonth. In the low demand growing instance, the growing rate of demand falls to 0.2 per cent per twelvemonth, whereas in the high demand growing scenario it is four per cent per twelvemonth. In the penultimate scenario, universe demand is turning at the rate assumed in the base instance, but the fringy extraction cost is changeless over clip.

This would reflect technological promotion such that the rise in extraction costs assumed in the base instance is precisely offset over clip. Finally, in the worsening extraction cost instance it is assumed that proficient alteration is sufficiently rapid so that the fringy extraction cost falls at 7.5 per cent per twelvemonth, while universe demand is turning at 1.5 per cent per twelvemonth. In the instances with a catcher resource, it is assumed that the resource is available at a monetary value of $ 50/barrel.

It is clear from panels A and B of Figure 3 that the Hotelling theoretical account can give qualitatively different consequences for the equilibrium production flight depending on the scenario considered. In the no and low demand instance, production diminutions monotonically – both with and without a catcher. In all other instances, production first rises and so diminutions to exhaustion in the absence of a catcher. It is besides possible that production additions monotonically until the resource is exhausted, as in the base instance, changeless cost, and high demand growing scenarios, and in the presence of the catcher ( Neha Khanna, 2003 ) .

Figure 3: Equilibrium Production Trajectories under Alternative Scenarios


The Hotelling theoretical account of resource depletion is the cardinal economic theoretical account used to analyse the issues associating to the usage of non-renewable resources. Under this theoretical account, resource proprietors seek to maximise the present value of net benefits obtained from pull outing the resource, given consumer demand for the resource and capable to the restraint that entire extraction can non transcend the initial resource stock. The optimum extraction determinations for each period in the production skyline are interdependent, since a unit of the resource extracted today is unavailable for extraction in the hereafter. The cardinal consequence obtained is that scarceness rent ( the difference between fringy gross and fringy cost, suitably defined ) increases at the rate of price reduction. The lone exclusion to this “ Hotelling regulation ” is the state of affairs where the fringy extraction costs depend on cumulative extraction. In this instance, the rent increases at a rate less than the price reduction rate. The difference is caused by the addition in fringy cost due to fringy decrease in staying militias. However, in all instances, the fringy benefit from extraction to the resource proprietor is precisely equal to the fringy economic cost at equilibrium.

The Hotelling regulation holds irrespective of whether the resource stock is owned by a monopoly or a absolutely competitory house. The difference lies in the definition of scarceness rent. Under perfect competition, each of countless houses faces a absolutely elastic ( horizontal ) demand curve, and fringy gross is indistinguishable to monetary value. Here rent may be defined as the difference between monetary value and fringy extraction cost. In the instance of a monopoly, the house faces a declivitous demand curve and monetary value exceeds fringy gross.

Therefore, scarceness rent is the surplus of fringy gross above fringy cost. Given the cardinal function of the price reduction rate in the Hotelling regulation, it is of import to observe that there is no sacred numerical value for the societal rate of clip penchant. Furthermore, the theoretical account assumes that private price reduction rates will be indistinguishable to the societal price reduction rate. It is merely under this premise, in add-on to the premise of a absolutely competitory market construction, that the equilibrium monetary value and production flights obtained are efficient.

The monetary value to the consumer is defined by the amount of the fringy extraction cost and the scarceness rent. The form and way of the monetary value flight, hence, depends on the interaction between these two factors. So long as the fringy extraction cost is lifting, monetary values will lift, though at a rate different from the price reduction rate. However, if the fringy cost is diminishing it is possible that this negative consequence dominates the scarceness rent, at least in the close term. In this state of affairs, the equilibrium monetary value flight will ab initio worsen but finally lift as the increasing scarceness rent begins to outweigh the worsening fringy cost. The flight may be monotonically increasing, monotonically diminishing, or may first addition, and so lessening.

Which of the production and monetary value flights obtained under the Hotelling theoretical account of resource depletion will be observed in the hereafter can non be predicted with assurance. The concluding result would be determined by the interaction of several forces, including many non-economic factors that are difficult to include in resource depletion theoretical accounts. But it is surely the instance that this theoretical account can foretell an array of believable monetary value and measure flight for non-renewable resources under a sensible set of premises. It ‘s now clear that a period of worsening monetary values ( chiefly induced by worsening extraction cost ) and speed uping ingestion is theoretically consistent with the eventual exhaustion of a non-renewable resource.