Nonrenewable resource economics

Assume the exploitation of a nonrenewable stock resource to be separated into two periods, period 1 and period 2. Let the initial resource size be

*S*. Assume further the quantity*q*(*t*) the be exploited each period,*t*= 1, 2. ThenAssume a constant unit price

*p*and the extraction cost,*c*, to be a function of extracted quantity,*q*. Net revenue of period*t*then isand the marginal net revenue is

We assume a discount rate

*r*. Then the present value of the net revenue of the two periods iswhich may be rewritten to

Maximization of present value is obtained when the relative change (percentage change) between the two periods equals the discount rate,

*r*, or:**The immediate gain of extracting one unit more should equal the long term discounted loss of not being able to extract this unit in the future.**

Since

*r*> 0 the optimal solution is obtained with an increasing nominal value of net revenue by time, as illustrated in the figure below.### The multi-period case

Consider the multi-period case. In principle there are no differences between the multi-period case and the two-period case. The results above is still valid when changing 1 and 2 by

*t*and*t*+ 1. We then haveand

Now let us assume the resource owner to have some degree of market power and that the demand is decreasing by increasing quantity extracted. The broad picture from the reasoning above still remains and we have

In 1931 Harold Hotelling showed how the optimal price was described by a curve defined by this equation. The simplest version of Hotelling's rule is expressed by

The price is a function of time.

**Faustman's equation** (simple version):

Delta i the interest rate an t the optimal length of the rotation period.

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