Environmental Economics (30L304)

Tutorial for Part 3

Renewable and non-renewable resource management

1 Non-renewable resource management

Suppose that the oil industry consists of 25 oil producers. Each oil producer
owns an oil well that contains 25 barrels of oil. Suppose that there are no
extraction costs, and that each oil producer aims to maximize the net present
value (NPV) of its oil revenues.

(1.A) Write down the Lagrangean maximization problem each oil producer
aims to solve, and explain the intuition behind the Lagrangean multi-
plier.

(1.B) Derive the first order conditions for NPV maximization.

Suppose that the interest rate is 10% (r = 0.1), and that the demand
function for oil is p = 1.5e−0.2q . The oil industry’s extraction, q(t), is
the aggregate amount of oil extracted by all oil produces at every point
in time.

(1.C) Sketch how the industry’s extraction path can be derived. (Hint: draw
the graph with the four quadrants). What requirement(s) must be
met for the extraction path to be optimal?

Suppose that the time at which all oil reserves are depleted, T , is
known.
(1.D) Mathematically derive the industry’s extraction path (q(t)). (Hint:
remember that for very short time periods, pt = p0 (1 + r)t can be
written as p(t) = p0 ert .)

(1.E) Calculate the time (T ) at which the aggregate resource stock is de-
pleted.

(1.F) At which price would oil be sold today? That is, what is p0 ? And what
is the current aggregate extraction level, q0 ?

(1.G) Suppose that a new oil deposit is discovered, containing 275 barrels
(that is, the known size of the oil stock increases by 44%; it is not 625
barrels in total, but 900).
When will we run out of oil now? What level would extraction jump to
today? Give the intuition behind these answers. Why does the deple-
tion time not increase by about 44% as well, if the size of the resource
stock is increased by 44%?

2 Renewable resource management

Consider a fish species that is characterized by (i) a logistic regeneration
process, (ii) an intrinsic growth rate of 0.2 (g = 0.2), and (ii) a carrying
capacity of 1000 tons (smax = 1000). Hence, the dynamics
of the fishery are
st
st+1 = st + Gt − ht , where Gt = G(st ) = 0.2st 1 − 1000 .

The maximum sustainable yield stock (smsy ) is defined as the stock size
that maximizes the amount of resources that can be extracted sustainably.
That is, the maximum sustainable yield stock maximizes hs subject to the
constraint that hs = G(s).

(2.A) Calculate the maximum sustainable yield stock level. What is the
maximum number of fish that can be harvested sustainably?

Consider the case of a fishery that lies completely within the jurisdiction
of one country. Suppose for the moment that harvesting is costless, that
the sales price (p) is constant and equal to 1.
(2.B) What is the country’s optimal long-run stock size, assuming that it
wants to maximize the net present value of the fishery? Compare your
answer to your answer to Question (2.A), and explain the similarity
between the two, and the differences. And what if the price had actually
been equal to 2 (i.e., p = 2)?

Now suppose that the harvesting function is h = αes, where α = 0.10

is technology and e is effort. That means that harvesting is now costly,
and suppose that the costs of using effort is equal to we, where w = 25.
Assume that all other parameter values remain unchanged (including
p = 1).

(2.C) What is the country’s optimal stock size, assuming that it wants to
maximize the profit flow that can be sustained for now and forever?
Show the deriveration, and explain the intuition behind it. Also calcu-
late the associated sustainable harvesting level. Compare your answer
to that to Question (2.B), and explain the difference.

(2.D) Suppose that there is open access, and not private property.
What is the long-run steady state level? What amount is harvested in
every period? (Hint: with open access, profits are zero and in steady
state aggregate harvest equals regeneration.)

(2.E) Suppose that the government accepts that it cannot regulate entry (i.e.,
everyone who wants to go fish, is allowed to), but that it can impose a
landing tax; all fisherboats that land on its shores, need to pay a tax
of τ = 0.6 per ton of fish brought on land.
Calculate the resulting open-access-with-landing-tax steady state re-
source stock, and compare your answer to that of (2.D). Did the govern-
ment set the tax rate that indeed maximizes the country’s net benefits
from managing the fishery?