Chapter-15
Theory of optimal resources Extraction: Non- Renewable Resources
Non-renewable resources include fossil fuels like oil, gas, and coal, as well as
minerals like copper and nickel. These resources take millions of years to form and
cannot be replaced once used.
People get value directly from using fossil fuels. Sometimes, other resources can
replace them, which affects how quickly they are used up.
There are two principal.
1. People get benefit from using the resource directly. If other non-renewable
resources can replace it, the use of the main resource may slow down.
2. This part does not include the harmful effects of using fossil fuels. But burning
fossil fuels is a major cause of air pollution. It creates most of the carbon dioxide,
sulfur dioxide, and nitrogen oxide in the air, which are very harmful to the
environment
The relationship between non-renewable resource extraction over time and
environmental degradation is so important that it warrants separate attention.
A Non- Renewable resource two-period Model
Assume there are two time periods: period 0 (now) and period 1 (later). A fixed
amount of a non-renewable resource, called R, is available at the beginning.
Let R₀ be the amount used in period 0, and R₁ in period 1. The total amount used
cannot be more than R.
The price of the resource in each period depends on how much is used. The demand
functions are:
P₀ = a − bR₀
P₁ = a − bR₁
Here, P₀ and P₁ are prices in each period, and a and b are positive constants. Using
more of the resource leads to a lower price in that period.
Figure 15.1 shows a linear, downward-sloping demand curve where demand drops to
zero at price a. This means the resource is either non-essential or has a substitute
that becomes more attractive at that price. The linear demand assumption is
arbitrary, so the results depend on this specific form. The shaded area in Figure
shows the total benefit B(Rt) from using amount Rt of the resource at time t, given by:
Gross benefit differs from net benefit because extracting the resource costs money.
We assume firms pay all costs, so private and social costs are the same. If cc is the
constant cost per unit, then total extraction cost is Ct=cRt
The total net social benefit from extracting the quantity R t is NSB=Bt −Ct.
A socially optimal extraction policy
The goal is to find the socially optimal extraction plan. This requires a social welfare
function showing society’s goals and the technical limits on extraction. The welfare
function used is discounted utilitarian. the general two-period social welfare function
W=W(U0 , U1 ) takes the particular form
ρ is the social discount rate showing how society values time. Utility each period
equals net social benefit, so the social welfare function is:
The only constraint is the fixed initial stock R. Society wants to use it all by the end of
period two,R0 +R1 =S.
The optimization problem can be stated
We use the Lagrange multiplier method to find out / solve this optimization.
The necessary conditions include:
This is similar as hoteling rule.
The left side of the equation, ρ is the social utility discount rate, showing how much
future utility is valued compared to present [Link] right side is the proportional
growth rate of the resource’s net price. An optimal extraction programme requires
two gross prices, P0 and P1 ,
A non-renewable resource multi-period model
The model shifts from two periods to continuous time, where optimality means:
Marginal social utility = Net price of the resource. Define P(R) as the net price (price
minus cost), depending on quantity extracted. Social utility comes from consuming R
which can be written as
The graph shows a downward-sloping, non-linear demand curve. The shaded area under the curve
represents total social utility from using quantity R. As extraction increases, net price decreases.
By differentiating total utility with respect to R
The discounted marginal utility is equal at each point in time, that is
Contradiction: If the discounted marginal utility from extracting the resource isn’t
the same in every period, then moving some extraction from a period with low utility
to one with higher utility would increase total welfare.
So Rearranging path of extraction,
This is, once again, the Hotelling efficiency rule. The rule says the net price Pt of a
nonrenewable resource must grow at the social discount rate ρ\rho to maximize its
social value.
We know the net price must rise at rate ρ\rho, but to fully solve the problem, we also
need to know:
1. The optimal initial net price.
2. The optimal extraction period T.
3. The extraction rate at each time.
4. The final net price and extraction at time T.
To answer the earlier questions, we need the resource demand function. Suppose
it’s:P(R)= K e-aR.
This non-linear demand better reflects real resource demand than the earlier linear
model. When R=0, price is K, the “choke price,” where demand drops to zero.
At the choke price, users switch to substitute resources or alternative products that
don’t rely on this resource.
Figure 15.3 shows the optimal resource extraction and net price over time for maximizing social
welfare.
Upper right: The net price rises exponentially over time at the social discount rate ρ\rho,
following Hotelling’s rule for efficient resource use.
Upper left: The resource demand curve is shown, featuring the choke price KK where demand
falls to zero.
Lower left: The optimal extraction rate decreases linearly over time as the resource stock is used
up.
Lower right: The time axis is mapped by a 45° line, linking extraction and price paths over the
time horizon until depletion.
Competitive vs monopolistic
Figure 15.4 shows that in monopolistic markets, the initial net price of the resource is
higher, but prices rise more slowly over time compared to perfect competition.
Resource extraction starts slower under monopoly but speeds up near the end of the
depletion period. This means a monopoly can help conserve the resource by delaying
its complete exhaustion.
Compared to perfect competition, a monopolist restricts output and sets higher
prices initially, but the price growth rate is slower. Overall, monopoly extends the
time over which the resource is used.
.