Allocation of Depletable & Renewable Resources

1. Allocation of Depletable & Renewable Resources Finite stocks of depletable resources – when do they get scarce?

2. 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 2009 – still availability reduces – demand rising – life style • New type of vehicles? – solar/wind/CNG? • What happens if no substitute or renewable resource is available? • Some like solar or surface water, are at constant MC

3. Concepts of stock of depletable resources • 3 concepts to classify: • Current reserves – known resources • Potential reserves – depends on how much people are ready to pay • Resource endowment – geological • Common mistakes in understanding concept: - to understand distinctions use data on current reserves - Fundamental error – understatement 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.

4. Other categories: - depletable, recyclable resources - copper - recyclable resource - Current reserves of depletable, recyclable resource can be augmented by economic replenishment & by recycling. - Their potential reserves can exhaust – depends 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

5. 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 humans – Fishing, soil erosion • For some flow independent of humans – solar • Some can be stored with proper facilities – solar 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

6. Storage of • Renewable resources - smoothens cyclical imbalances of demand & supply – can create buffer stocks • Depletable resources - extends their economic life • Challenge for depletable resources: allocating dwindling stocks among generations • Once depletable resources’ stocks dwindle we tend to go to renewable resources – then we must sustain their flow • Challenge for managing renewable resources: maintenance of an efficient & sustainable flow

7. How to respond to these challenges? • Depletable doesn’t run out suddenly • When there is a substitute renewable resource available to a depletable resource at constant marginal cost – oil & solar energy • Transition will happen if its MC < maximum willingness to pay – MC of Dpl res will not exceed beyond MC of Renwl res, as society will move to RR when it is cheaper • Maxm willingness to pay (choke price) sets upper limit – on total marginal cost when no substitute is available • MC of extraction of the substitute sets upper limit on the price when one is available • Quantity extracted gradually falls as MC rises until switch is made to the substitute

8. Switch Point • If a renewable resource is available, more of depletable will be extracted - in the future new resource is available • Depletable resource exhausted sooner • At switch point (transition point) Cn of RR begins • Consumption sequencing: Depletable resource  switch point  renewable resource • Transition from one constant cost depletable resource to another depletable resource with a constant but higher MC • When total MC of 1st resource would  and then when is = MC of 2nd, at time of transition

9. MC rises slowly for 2nd resource, at least initially. • Total MC = MEC + MUC. In both MEC is constant while MUC increases at rate r. At the time of transition MEC constitutes much larger proportion of TMC for 2nd resource than for 1st. TMC1 TMC2 Price MECost2 MExtrCt1 T* O Time Transition Point

10. 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 extracted – 1st grade then 2nd gr • Dynamic efficient allocation by maximising PV of NB using modified cost of extraction function • MUC falls over time & at transition it goes to zero • MUC – opportunity cost reflecting forgone future marginal net benefits • Under increasing cost every unit extracted increases the cost of extraction

11. As current MC rises over time, sacrifice made by future generations falls – net benefit received by them, 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 exhausted – under increasing some is left • History: Cost of depletable resource (oil) has ⇧ over time • ∴ resources are not used efficiently?

12. Role of exploration & technological progress • Exploration for new resource? Technological progress? – these two are significant in determining actual consumption path • New resource’s search is expensive – MEC  • Solar used in India – costly installation – but if oil prices ⇧ all the time – solar is future • ⇧ MC of known resource larger the potential in net benefits from exploration • With low MC new resource → ⇧ consumption • With no new resource Cn falls • More extraction with technological progress

13. Market Allocations • Actual markets – efficient allocation? • Profit maximisation compatible with dynamic efficiency? • Resource in the ground has 2 potential sources of value to owner – use-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 production to maximise the value of resource • In prescient competitive market P of res = TMC of extracting & using the resource

14. Generally TMC curve shows changes in the prices over time – expected • All other costs except evn costs are borne by the producer – e.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. Damage – P ↑ & DD  - Rate of Cn lower - time of transition later • Environmental & natural resource decisions are intimately linked

15. To sum up, • Efficient allocation of depletable & renewable resources depends on circumstances • When extracted at constant MC, efficient quantity of DRes extracted over time declines smoothly to zero • If renewable constant-cost substitute is available the quantity of DRes extracted will  smoothly • In both cases, all available DRes will be used up& MUC will  over time and will be maximum when last unit is is extracted • Technological progress (doesn’t allow MC to rise) & exploration (expands size of current reserves) activity tend to delay the transition to renewable resources • Market allocation of DRes can be efficient when PR structures are properly defined