Session 2: Allocation of

non renewable resources

ECON 16200
Natural Resource and Environmental Economics
Department of Economics, Faculty of Economics
 Scarcity
If Demand = P= 8–0.4Q;
Marginal Cost = $2
Then optimal where
Marginal Benefit (MB) = Marginal Cost
8–0.4Q = 2
0 = 6–0.4Q
Q = 15
P = 8–0.4(15) = 2
Therefore Q* = 15; P* = $2
For each period, we need to produce 15 Qs,
ceteris paribus. This is the static
efficiency solution.
For two periods, we need to produce 30 Qs
The case of abundant
resource (no scarcity)
The case of abundant
resource (no scarcity)
 The case of scarcity

What if we only have a stock of

20? How do we divide the use
between 2 periods? This is the
dynamic efficiency problem.
There is marginal user cost due to
scarcity. Marginal user cost
reflects the opportunity cost of
using the resource now and not
leaving it for future use.
 Marginal Benefit (MB) = P = 8–0.4q
MC = 2
Marginal Net Benefit = MB – MC
MNB = 6–0.4Q
If
Q = 0; MNB = $6
Q = 1; MNB = $5.6
Q = 2; MNB = $5.2
Q = 3; MNB = $4.8
…. and so on for Q = 4…. 20.
Use this information to draw the MNB
graph
Note, if we are facing a dynamic
scarcity problem, then we have
to calculate the optimal
extraction for period 2, 3 and so
on.
In this case, we need to calculate
the PRESENT VALUE of the MNB
of period 1, 2 and so on.
Discounting is then needed.

What discount rate to use?

 Discount rates
Different across people
- Risk lover or risk averse?
- Have access to which market?
– Stock exchange market?
– Pawn shop?
– Natural resource extraction
business?
– Family business?
– Lending business?
To calculate:
Present Value (PV) MNB2 =
MNB/(1+r)t
Where:
r = interest rate or other rate of
return applicable to the person
(generally, for the population as
a whole we use the bank rate of
interest for savings account)
t = time
Below, PV MNB for period 2 calculated
at 10% rate of discount
Criteria of dynamic efficiency:
MNBPERIOD1 = PV MNBPERIOD2
Criteria: PV MNBPERIOD1 = PV MNBPERIOD2
r = 10%
Q1* = 10.238; Q2* = 9.762
P1* = $3.905; P2* = $4.095
 Hotelling rule
P1* = $3.905; P2* = $4.095
MC = $2
Marginal user cost/scarcity rent: P – MC
Marginal user cost1 = $3.905 – $2
= $1.905
Marginal user cost2 = $4.095 – $2
= $2.095
MUC2 = (1+r)*(MUC1) 🡪 Hotelling Rule
 Extraction
without
Extraction path
substitu-ti
on

Time

Price path

(MC)

Time
 Homework
(do yourself, to prepare for quiz/exam; no
need to submit to me)
Using the numbers here, calculate if r is:
– 5%
– 20 %
If MC is:
- $1.5
- $2.5
What will happen to the rate of extraction?
Faster (i.e. more extraction in the early
periods)? Slower?
 Group Work 2 Due Wed 1 March
(note new group assignment)

1. Read PB Ch 2 and answer the following

questions:
- What does Prof Emil Salim mean about
changing paradigms?
- What are the new paradigms he proposed?
2. Do Tietenberg & Lewish Ch 5
- Discussion Question 1
- Self Test Exercise 1-5