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Allocation ofDepletable & Renewable Resources

Finite stocks of depletable resources

when do they get scarce?

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When demand is in excess, Should we allow

the system to collapse? Price of oil high $147+ in June 2008 - falls in

2008 to a low $32 in Dec 08 - now rises$ 69

on Oct, 05 2009still availability reducesdemand risinglife style

New type of vehicles?solar/wind/CNG?

What happens if no substitute or renewableresource is available?

Some like solar or surface water, are atconstant MC

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Concepts of stock of depletable resources

3 concepts to classify:

Current reservesknown resources

Potential reservesdepends on how much people

are ready to pay

Resource endowmentgeological

Common mistakes in understanding concept:

- to understand distinctions use data on current reserves -

Fundamental errorunderstatement of time- Assuming that entire resource can be made at a price that

people are ready to pay

We can never determine actual size of endowment.

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Other categories:

- depletable, recyclable resources - copper

- recyclable resource

- Current reserves of depletable, recyclable resource

can be augmented by economic replenishment & byrecycling.

- Their potential reserves can exhaustdepends on

demand & durability and ability to reuse the products- All depletable resources are not recyclable/reusable

coal, oil & gas once heated escape in atmosphere

non-recoverable

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- All depletable resources are finite

- Reusing & recycling makes them last longer

- Renewable resources can be replenished - naturally- For some, continuation & volume of flow depends on

humansFishing, soil erosion

- For some flow independent of humanssolar

- Some can be stored with proper facilitiessolar energy

converted to biomass by photosynthesis.

- A different service is provided by storage of renewable

resources than storage of depletable resources.

Can serve as means to

smoothen out cyclical

imbalances of SS & DD

Extends their

economic life

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Storage of

Renewable resources - smoothens cyclicalimbalances of demand & supplycan create bufferstocks

Depletable resources - extends their economic life

Challenge for depletable resources: allocatingdwindling stocks among generations

Once depletable resources stocks dwindle we tend togo to renewable resourcesthen we must sustain

their flow Challenge for managing renewable resources:

maintenance of an efficient & sustainable flow

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How to respond to these challenges?

Depletable doesnt run out suddenly

When there is a substitute renewable resource availableto a depletable resource at constant marginal costoil &solar energy

Transition will happen if its MC < maximum willingness

to payMC of Dpl res will not exceed beyond MC ofRenwl res, as society will move to RR when it is cheaper

Maxmwillingness to pay (choke price) sets upper limiton total marginal cost when no substitute is available

MC of extraction of the substitute sets upper limit on theprice when one is available

Quantity extracted gradually falls as MC rises until

switch is made to the substitute

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Switch Point

If a renewable resource is available, more of

depletable will be extracted - in the future newresource is available

Depletable resource exhausted sooner

At switch point (transition point) Cnof RR begins

Consumption sequencing: Depletable resource

switch point renewable resource

Transition from one constant cost depletable resource

to another depletable resource with a constant buthigher MC

When total MC of 1stresource would and then

when is = MC of 2nd, at time of transition

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MC rises slowly for 2ndresource, at least initially.

Total MC = MEC + MUC. In both MEC is constant

while MUC increases at rate r. At the time oftransition MEC constitutes much larger proportion of

TMC for 2ndresource than for 1st.

Price

Transition Point Time

MExtrCt1

MECost2

TMC1 TMC2

O

T*

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Increasing marginal extraction cost (MEC)

Efficient allocation of DRes in longer time +availability of other DRes that are perfect substitutes

Situation: When MEC of depletable res. rises with

cumulative amount extracted1stgrade then 2ndgr

Dynamic efficient allocation by maximising PV of

NB using modified cost of extraction function

MUC falls over time & at transition it goes to zero

MUCopportunity cost reflecting forgone futuremarginal net benefits

Under increasing cost every unit extracted increases

the cost of extraction

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As current MC rises over time, sacrifice made by

future generations fallsnet benefit received bythem, if a unit of resource is saved for them gets

smaller & smaller, as MEC gets larger & larger

Opportunity cost of current extraction drops to zero &

TMC = MEC at switch point Under constant cost reserve gets exhaustedunder

increasing some is left

History: Cost of depletable resource (oil) has

overtime

resources are not used efficiently?

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Role of exploration & technological progress

Exploration for new resource? Technologicalprogress?these two are significant in determiningactual consumption path

New resources search is expensive MEC

Solar used in Indiacostly installationbut if oilprices all the timesolar is future

MC of known resource larger the potential in netbenefits from exploration

With low MC new resource consumption With no new resource Cn falls

More extraction with technological progress

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Market Allocations

Actual marketsefficient allocation?

Profit maximisation compatible with dynamicefficiency?

Resource in the ground has 2 potential sources of value

to owneruse-value: when sold & asset-value: when

in ground

While price rises in-ground is getting more valuable

capital gain when conserved

A wise producer balances present & future productionto maximise the value of resource

In prescient competitive market P of res = TMC of

extracting & using the resource

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Generally TMC curve shows changes in the prices

over timeexpected All other costs except evn costs are borne by the

producere.g. health risks, acids in water from

mines - if no outside attempt to internalise it, will not

be part of extraction decision If MC is by cost of env. DamageP & DD -

Rate of Cn lower - time of transition later

Environmental & natural resource decisions areintimately linked

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To sum up, Efficient allocation of depletable & renewable resources

depends on circumstances

When extracted at constant MC, efficient quantity ofDRes extracted over time declines smoothly to zero

If renewable constant-cost substitute is available thequantity of DRes extracted will smoothly

In both cases, all available DRes will be used up& MUCwill over time and will be maximum when last unit isis extracted

Technological progress (doesnt allow MC to rise) &exploration (expands size of current reserves) activitytend to delay the transition to renewable resources

Market allocation of DRes can be efficient when PR

structures are properly defined