Journal of Economic Dynamics and Control 8 (1984) 19-32.

North-Holland

COMPETITIVE PRICE PATHS OF AN EXHAUSTIBLE

RESOURCE WITH INCREASING EXTRACTION COSTS*

Hajime HORI
Tohoku University. Kawauchi. Sendai 980, Japan

Received February 1983, final version received June 1984

The paper analyzes the competitive growth paths of an economy with an exhaustible resource
which is subject to increasing extraction costs, assuming perfect foresight. It establishes equiva-
lence among the competitive present-value maximization condition for deposit holders, the
generalized Hotelling rule, and the Ricardian royalty-price structure. It also proves uniqueness of a
competitive growth path for the case where a backstop technology exists, in order to give some
validity to the assumption of perfect foresight.

1. Introduction

There seem to be at least two different ways of characterizing the exhausti-

bility of an exhaustible resource. One is to view that its total supply, and
therefore its total cumulative consumption possibility, are finite. The other is to
view that the extraction costs increase as extraction proceeds, allowing the
possibility of infinite cumulative consumption. The first rigorous analysis of
the competitive price paths of an exhaustible resource characterized by finite
supply was given by Hotelling (1931), and his analysis was later amplified by
Stiglitz (1974) and Dasgupta (1974). The purpose of the present paper is to
analyze the competitive price paths of an exhaustible resource characterized by
increasing extraction costs. Although some properties of such paths were
already discovered by Heal (1976), Solow and Wan (1976) and Dasgupta and
Heal (1979), the direct concern of the first two works was optimum growth,
while the third work adopted a partial equilibrium approach. In the present
paper, we will present a general equilibrium analysis of the competitive price
paths of an exhaustible resource. In particular, we will establish equivalence
among the present-value maximization behavior of deposit holders, a
Hotelling-type price evolution equation of the exhaustible resource, and a
Ricardian differential royalty-price condition.

*An earlier version of the present paper was presented at the economics workshops of the
University of Iowa and Tulane University and at a CESG meeting in Tokyo. The author is grateful
to Professors L. Hurwin, A. Takayama and J. Rennan for useful comments and suggestions.

0165-1889/84/$3.0001984, Elsevier Science Publishers B.V. (North-Holland)

20 H. Hori, Contperitivepricepaths of an exhawtible resource

The layout of the paper is as follows. Section 2 introduces the model, which
is essentially the same as the one used by Heal and Solow and Wan, except
that our approach is descriptive. Section 3 defines a competitive price path of
an exhaustible resource and relates it to a Hotelling-like price evolution
equation, assuming perfect foresight, among other things. Section 4 introduces
the static concept of a royalty-price schedule of an exhaustible resource and
establishes a one-to-one correspondence between a royalty-price schedule and
a dynamic price path. Section 5 proves the equivalence among the present-value
maximization condition, the Hotelling-type price evolution condition, and the
Ricardian royalty-price condition. Finally, section 6 argues that uniqueness of
a competitive path is essential for the validity of the perfect-foresight assump-
tion, and proves the uniqueness for the case where a backstop technology
exists.

2. The model
The model to be used is essentially a neoclassical aggregate growth model
with an exhaustible resource as a factor of production. Let us first consider the
supply side of the exhaustible resource.
Throughout most of the paper we assume that total supply of the resource is
infinite but the resource deposits differ in quality, the differences being
represented by the differences in the costs of extracting a unit of the resource
from different deposits. Label the deposits in order of quality so that the label
of a deposit, Z, also designates the total amount of the resource contained in
the preceding (i.e., better in quality) deposits.
Let G(Z) denote the marginal and average cost of extracting the resource
from deposit Z. [Thus, if R is the rate of extraction of the resource, then the
total flow cost of extracting R from Z is G(Z)R.] We assume that G(a) is
twice continuously differentiable except possibly at some Z and satisfies

G(Z)’ 0, vzzo,
and
G’(Z)>O, vz, ojz<z,
0)
= 0, VZ>=Z,

where 2 is the cumulative level of extraction at which a backstop technology

becomes effective. [Suppose a backstop technology for the resource is available
at the flow average cost of G. Then z is defined by G( 2) = G.] We take 2 to
be infinite if such a technology does not exist.
Let P(t) and r(t) denote the price of the exhaustible resource and the
interest rate at time I, and let E(t) = exp( /,,‘r( 7) dr), the discount factor. We
 H. Hori, Competitiuepricepaths of an exhoudble resource 21

assume that the deposit holders are present-value maximizers and know the
whole price path P(a) and interest-rate path r( .) [and therefore E( .) also]. The
present value of deposit Z, if mined at time t, is given by [P(t) - G( Z)]E( t)- ‘.
Therefore the optimization problem for the holder of deposit Z is to find a
t 2 0 that satisfies

[f’(+G(Z)]E(t)-‘2 [P(u)-G(Z)]E(u)-‘, vu~o, (2)

and
P(t)-G(Z)xO. (3)

It is useful to note at this point that the oft-cited better-deposit-first

principle holds concerning the optimum supply times for various Z’s given by
(2) and (3). Namely, if ti is an optimum supply time for Zi, i = 1,2, and Z, < Z,,
and if r(t) > 0 for all t 2 0, then t, 5 t,. In fact, suppose that t, > t2. Then
supplying Z, at t, and Z, at t,, one obtains the following addition to the
combined present value of Z, and Z,:

[f’(h) - G(G)]E(b)-’ + [P(b) - G(Z,)lE(b)-’

- [J’(h) -G(G)] E(h)-’ - [f’(b) -G&)1 E(fd-’
= [G(z,)-G(z,)~[E(~,)-‘/E(I,)-‘-~]E(~,)-’.
The first factor in the right-hand side is the cost differential between Z, and Z,
and is positive. The second factor is equal to exp[ j,‘lr(7)d7] - 1, which is the
interest that accrues to the saved cost differential between t, and t, and is
positive. Thus the whole expression is positive, which contradicts the assumed
optimality of 1, and t,. This contradiction proves that f1 2 t,.’
Let us next turn to the demand side. We assume that the exhaustible
resource is used only as an input to the aggregate production process and is not
consumed directly.
At time t, total output is produced from capital K(t), labor L(t), and flows
of the exhaustible resource R(t) according to a production function
&( K(t), R(t), L(t)). (In the sequel, reference to t will be omitted unless
necessary.) We assume labor L(t) to be constant, so that we can suppress L
and write the production function F(K, R). In addition to twice continuous

‘A rigorous proof of this principle for an optimal extraction path was given by Solow and Wan
(1976). See Kemp and Van Long (1980), however, for examples in which the principle does not
hold. A heuristic account of the validity of the principle for a competitive path was given by
Dasgupta and Heal (1979).
22 H. Hori, Competitive price paths of an exhamtible resource

differentiability, we assume the following:

&(K,R)>O, ,Fl,,(K,R)<O, VK>O, VR>O, i=K,R,

&tK, R) ’ 0, VK>O, VR>O,

limF,(K,R)=oo, lim &(K,R)=O, VK>O. (4)
R-r0 R-rCQ

Producers, who are assumed to be price takers, will demand that R which
maximizes F( K, R) - PR. Let R( K, P) denote the unique optimum solution.
R( K, P) is continuously differentiable and satisfies

R( K, P) ’ 0, F(K,R(K,P))-PR(K,P)>O,

R.(K,P)>O, R,(K,P)d, VK>O, VP>O. (5)

The economy’s net output is equal to F(K, R) - G(Z)R, which is either
consumed or invested. Assume, for simplicity, that a constant fraction s of net
output is invested. Thus

k=s[F(K,R(K,P))-G(Z)R(K,P)], O<s<l. (6)

3. Hotelling-type price evolution equation

We now combine the supply and demand sides to obtain a competitive
growth path on which the demand for and the supply of the exhaustible
resource are equal.
For this purpose, note first that, in analyzing a competitive growth path, we
can assume that the better-deposit-first principle also holds for demand,
because it holds for supply and supply is equal to demand on a competitive
path. With this convention, the cumulative demand for the, resource between
time 0 and f, given by /,,'R(K(7), P(r))dT, also represents the label of the
deposit demanded at tune t. Let the latter be denoted by Z(t). Then Z(t) =
~c,‘WW, P(T))d 7; or, differentiating both sides with respect to t, we obtain

~=R(K,P). (7)
Now, given an arbitrary twice continuously differentiable price path of the
exhaustible resource P( 0) : R++ R (also written P* when convenient), the set
of differential equations (6) and (7) generates a unique solution path because
Z(O),= 0 by definition and because the right-hand sides of (6) and (7) are
continuously differentiable. Let K(t; P*) and Z(t; P*) denote this solution
 H. Hod, Competitive price paths of an exhaudble resource 23

path. Z( t; P*) is the label of the deposit demanded at time t (and therefore
the cumulative demand for the resource between time 0 and t) under the price
path P*. The interest rate along this solution path is given by

r(t; P*)=F,(K(t; P*),R(K(t; P*),P(t))), (8)

and the corresponding discount factor is denoted by E(t; P*).

In order for the price path P* to be an equilibrium price path, therefore, it
is necessary and sufficient that the deposit labelled Z(t; P*), and nothing else,
be supplied at each t 2 0. A set of necessav conditions for the latter is given by

[P(t)-G(Z(t; P*))]E(t; P*)-’

2 [P(U)-G(Z(t; P*))]E(u; P*)-‘, VtgO, vu>=o, (9)

P(t) - G(Z(r, P*>) 2 0, VtzO, 00)
and
P(t) 5 G(Z), vz 2 lim z(7; p’*),
7+*
Vt 2 0, 01)

and a set of suficient conditions is given by (9), (IO), and

P(t) < G(Z), VZ2 lim Z(7; P*), VtzO. (12)

7’00
Inequalities (9) and (10) are obtained by substituting Z(t; P*) for Z and
E(.; P*) for E(s) in (2) and (3), th e necessity of which for Z(t; P*) to be
supplied at t has been demonstrated already. Inequality (11) is also necessary
because on an equilibrium path, no deposits other than the ones demanded
should be supplied. In order to show that (9),,(10) and (12) are sufficient, it will
suffice to show that inequality (9) holds strictly for 1# u if (9), (10) and (12)
hold; then (9), (10) and (12) guarantee that Z(t; P*), and nothing else, will be
supplied at each t 2 0. But the strict version of inequality (9) follows from the
better-deposit-first principle. In fact, suppose that the present value of Z is
maximized at t, and t, and that t, # t,. Then, by the better-deposit-first
principle, nothing but Z will be supplied between t, and t,, and therefore flow
supply of the resource between t, and t, will be zero almost everywhere. Since
flow demand for the resource is positive at any time, supply cannot be equal to
demand, and this contradiction proves the assertion.
Thus, a competitive price path of the exhaustible resource P* for which the
supply of and the demand for the resource are equal is completely char-
24 H, Hori, Competitive price paths of an exhaustible resource

acterized by (6) (7), (9), (10) and (11) [or (12)]. In the sequel, we will call
inequality (9) the present-value maximization condition, inequality (10) the
non-negatiuity condition, and inequality (11) [or (12)] the boundary condition.
Let us derive a few useful properties of a competitive price path of the
exhaustible resource. Firstly, unlike the case of constant extraction costs where
deposit holders are always indifferent betwen exploiting and keeping the
deposits, the optimum exploitation time for each deposit is unique and given
by the inverse function of Z(t; P*), as we have seen just above.
Secondly, a strict version of the better-deposit-first principle holds on a
competitive path in the sense that if ti is the optimum supply time for Zi and
Z, -CZ,, then t, -Ct,. To see this, suppose that t, = t,. Then by the uniqueness
of the optimum supply time and by the principle, all the Z’s between Z, and
Z, will be supplied at t1 = t,, which contradicts the assumed equality between
flow supply and demand.
Thirdly, (9) implies that the derivative of [P(u)- G(Z(t; P*))]E(u; P*)-1
with respect to u vanishes at u = t. Thus,

P(t)= [P(t)-G(Z(t; P*))]r(t; P*). (13)

Actually, it can be shown that (9) hola!s if and only if (13) holds. The proof of
sufficiency of (13), however, will be postponed to section 5.
If we let e(t) = P(t)- G(Z(t; P*)), the royalty price of the deposit Z(t; P*)
at time t, (13) can be rewritten as

(5!=Qr-c, 04)
which clearly shows that (13) is a generalization of the Hotelling rule to the
case of differential extraction costs. For this reason, we will refer to (13) as the
generalized Hotelling rule. [EQ. (14) as an optimality condition is discussed in
Heal (1976) and Solow and Wan (1976). As a competitive condition, it is
discussed in Peterson and Fisher (1977) and Dasgupta and Heal (1979).]
Thirdly, (10) and (13) show that the price of an exhaustible resource is
non-decreasing over time.

4. Ricardian royalty-price schedule

In order to make the implications of the inequalities (9), (10) and (11) [or
(12)] more explicit, let us consider the discounted present value at time t = 0 of
the royalty price of each deposit Z.
Given a price path P*, which need not be a competitive path, let t(Z; P*)
be the inverse function of Z(t; P*). This function represents the time at which
the deposit Z is demanded. The present discounted value at time zero of the
 H. Hori, Competitive price paths of an exhaustible resource 25

deposit Z under the price path P* is given by

Q(Z;p*)=[p(t(z;~*))-G(Z)]E(t(z;p*);p*)-’, (15)

for all Z, 0 5 Z c lim , _ ,Z( t; P *). Under the stipulated assumptions,

Q( Z; P*) is twice continuously differentiable. Let us call Q(Z; P*) a royalty-
price schedule in the base year.
Given a smooth Q(e): R+-, R,, on the other hand, a price path P* that
satisfies Q( -) = Q(. ; P*) is uniquely determined. To see this, first note that the
functions K( . ; P *), Z(. ; P *) and E( . ; P *) depend on P * through differen-
tial equations (6) and (7). Next differentiate both sides of E(t; P*) with
respect to t and note that r(t; P*)=F,(K(t; P*),R(K(t; P*), P(t))) to
obtain

B=EF,(K,R(K,P)). 06)

Now, since Q(t) = Q( t; P *), P has to satisfy

P=G(Z)+Q(Z)E, (17)

where the reference to I is omitted. Substitute (17) for the P in (6), (7) and (16)
to obtain a system of three differential equations for the three unknown
functions K, Z and E. These differential equations have continuously differen-
tiable right-hand sides if Q( .) is continuously differentiable. Since the initial
values are given by K(0) = K,, Z(0) = 0 and E(0) = 1, a solution is unique. By
substituting Z(e) and E(a) in (17), we obtain a price path P(e) = P* which
clearly satisfies Q( .) = Q( a; P*). When there is a need to express the depen-
dence of such functions as K(e), Z( .) and P(e) on a particular royalty-price
schedule Q(e) = Q*, we will write K(.; Q*), Z(*; Q*) and P(*; Q*).
Therefore we have established that (1) each P* uniquely determines Q(Z)
for Z < lim ,-,Z(r; P*), and (2) each Q* uniquely determines P*. The
inconsequential possible multiplicity of Q* for a given P* can be eliminated if
we deal with the class of functions [Q*] instead of Q* itself, where

Thus we have a one-to-one correspondence between P* and [&*I. In the

following, however, I will write Q* for [Q*]; this will cause no confusion.
26 H. Hori, Conrperitivepricepathhs of an exhaustible resource

5. Equivalence of the three conditions

In terms of the royalty-price schedule the present-value maximization condi-
tion takes the following form: A price path P* satisfies the present-value
maximization condition if and only if the royalty-price schedule Q* satisfies

Q’(Z)= -G’(Z)E(t(Z;Q*);Q*)-‘, OsZ<,ttZ(t;Q*). (18)

- G’(Z) measures how the average (and marginal) productivity of the deposit,
given by F(K, R)/R - G(Z), differs between adjacent deposits. Thus (18)
states that the difference in the base-year royalty price is given by the
discounted present value of the difference in the productivity. For this reason
we will refer to (18) as the Ricardian royalty-price condition [see Ricardo
(1817)].
I will prove the equivalence of the present-value maximization condition (9),
the generalized Hotelling rule (13) and the Ricardian royalty-price condition
by proving the implications (13)* (18)= (9). [That (9) implies (13) has been
shown in a preceding section.]
In order to prove that (13) implies (18), differentiate both sides of Q(Z) =
Q( Z; P *) [ Q( Z; P *) is defined by (15)] with respect to Z to obtain

Q’(Z) = [ (P(t(Z)) - (f’(t(Z))

-G(Z))r(t(Z))}q- G’(Z)]E(t(Z))-‘.

If (13) holds, then the expression within the braces vanishes and therefore (18)
follows.
In order to see that (18) implies (9), we first derive a pair of inequalities from
(18). For Z < 2, we can divide both sides of (18) by -G’(Z) to obtain
- Q’(Z)/G’(Z) = E(t(Z))-‘. Since the right-hand side of this equation is
decreasing in Z, so is the left-hand side. Thus, if 0 s Z, < Z, < 2, then

-*(G(z,)-G(zl))= -*kycyz)dz
1 1

= - (Q(z,) - Q(z,))~
 H. Hori, Competitive price paths of an exhaustible resource 21

and similarly,

-,$+(Z,) - G(Z,))< -(Q(Zd - Q(zd).

2

Combining these two inequalities, we obtain

Q'(Z1) > _ Q(T) - Q(Z2)

G’(G) G(G) - G(Z,>

> Q’(Z2)
0 $ z, < z, < z.
G’(Z2) ’

Using - Q’( Z,)/G’( Zi) = E(t(Zi))-’ again, noting that E(t( Z)) is well-
defined, continuous, and increasing in Z for Z_z Z also, and noting that
G(Z_) = G(Z) for $ Z 2 Z by the definition of Z and that therefore Q(Z) =
Q(Z) for all Z 2 Z by (18), we obtain

> E(t(Z,))-‘, O~Z,<Z, z,<z,. (19)

Now, to see that (18) implies (9), let D denote the left-hand side minus the
right-hand side of (9). Writing Z, = Z( u; Q*) and Z, = Z( t; Q*) and using
Q(t)=Q(t;P*)toeliminateP(u)=P(t(Z,))and P(t)=P(t(Z,)),weobtain

D = [Q(T) - Q(Z,,>]+ [G(Z,) - G(z,)lE(dZ,))-‘-

If Z”=Z,, then D-O. If Z,#Z,, Z,,hZand Z,zZ, then G(Z,)=G(Z,)
and therefore Q(Z,) = Q(Z,) by (18). Thus D = 0. If Z, # Z, and either
Z, < 2 or Z, < z, then D > 0 by (19). Therefore (9) holds, and the proof of the
equivalence of the three conditions is complete.

6. Validity of the perfect-foresight assumption

In the preceding sections, we derived some properties of a competitive price
path of an exhaustible resource, and, in particular, we proved the equivalence
among the present-value maximization condition (9), the generalized Hotelling
rule (13), and the Ricardian royalty-price structure (18), assuming that foresight
wus perfect. But the assumption of perfect foresight (or self-fulfilling expecta-
28 H. Hori, Competitive price paths of an exhaustible resource

tions, or rational expectations) is admittedly a very strong one. In order not to

strain this assumption excessively, uniqueness of a competitive price path
seems essential for the following reason.
At each moment of time, asset holders form expectations of the possible
future asset prices, and these expectations determine the current asset prices
through their influences on the portfolio compositions. The conditions which
have to be satisfied in order for the actual prices to follow the expected price
paths, in other words, in order for the expectations to prove correct, will be
something like the folIowing.
Firstly, asset holders must have the exact knowledge of the basic structure
of the economy; more specifically, they have to know the production function,
the demand function for the resource, the extraction-cost function, the savings
behavior, and the objective of all the asset holders. Secondly, based upon this
knowledge, they must calculate the possible equilibrium prices for the whole
future because, if we adopt the discrete time formulation just for the present
heuristic discussion, P(t) wilI depend upon the expectations of P(t + l),
P( t + 1) will depend upon the expectations of P( t + 2), and so on ad injinitum.
These two conditions will be sufhcient for perfect foresight if a competitive
price path is unique. Actual market prices will necessarily follow the expected
price path because this is the only path equilibrium prices can take. In this
case, although the conditions are still stringent, one could probably argue that
the model would be structurally stable, namely that a sound knowledge of the
structure of the economy and a long forecast horizon on the part of asset
holders would yield price paths which are close to the perfect-foresight price
path.*
If there exist multiple ‘perfect-foresight’ equilibrium price paths, however,
these conditions will not be sufhcient to produce perfect foresight. To see this,
suppose there exist multiple perfect-foresight equilibrium price paths. In terms
of our model, it means that, for a given initial capital stock K,, there exist
multiple initial prices for which our system of dynamic equations (6), (7) and
(13) (or its difference-equation version) has solutions that exist and satisfy the
non-negativity condition (10) and the boundary condition (11) for all t 2 1.
Therefore the market has to choose one from among the multiple possible
initial prices, all of which are consistent with the conditions of exact knowledge
and infinite forecast horizon. Let P; denote the chosen initial price and let
{ P,‘}Ei denote the corresponding price solution of our dynamic system.
In the next period, the market faces the same problem of choosing one from
among many possible second-period prices because, unlike such variables as
physical capital stocks or cumulative resource extraction, the asset price in

‘See Hori (1982) for an analysis of the dynamics generated by these two requirements (and not
by the assumption of perfeet foresight) and its structural stability with respect to the length of the
forecast horizon.
 H. Hori, Competitive price paths of an exhaustible resource 29

each period is not a given datum inherited from the past. [This point has
recently been given attention; see, e.g., Blanchard (1979).] If so, is there any
mechanism that forces the market to choose the Pi, the second-period price
that is consistent with the P; chosen in the first period, in accordance with the
assumption of perfect foresight? The answer seems no. Although the choice by
the market of a different price from Pi will entail different rates of returns to
different assets, there is no way of arbitraging among them when prices are
determined sequentially. As in the time inconsistency paradox of an optimum
plan discussed by Kydland and Prescott (1977), alternatives which were
available for arbitraging in the past become no more available as time passes
by. Thus, if we let P,(‘) denote the t th period price of the resource chosen by
the market in the tth period, then the sequence { P/‘)}Ea,l will usually be
different from any of the perfect-foresight price paths. In this situation, to
assert that { P,‘) z I, which is one of the perfect-foresight price paths, be chosen
will be an abuse of the assumption.
For this reason we now turn to the question of uniqueness of a competitive
price path.3 Since we know that (13) is equivalent to (9), oursystem consists of
the three differential equations (6), (7) and (13), the non-negativity constraint
(lo), the boundary condition (11) or (12), and the initial conditions K(0) = K,
and Z(0) = 0. In the present context, the price path P( 0) is an unknown
function.
Let us transform our boundary condition (11) or (12) into a form which is
more amenable to the uniqueness analysis. In order to take into_account the
possibility of finiteness of the total stock of the resource. Let Z denote the
total stock which may be finite or infinite. Thus our boundary conditions (11)
and (12) are, respectively,

P(t) s G(Z), vtzo,

VZ such that lim Z(t; P*)$Z<Z=, (20)
fdrn

and

P(t) < G(Z), vtgo,

VZ such that lim Z(t; P*)$Z<Z=. (21)

r-m

‘Uniqueness of a solution for a model with perfect foresight has been considered by, e.g., Shell
and Stiglitz (1967), Brock (1974), Sargent and Wallace (1973) and Taylor (1977). The approach
taken in this paper is along the line of Shell and Stiglitz and Brock in the sense that it seeks the
uniqueness of a price path which is compatible with individual rationality, ,without imposing
additional conditions such as stability or minimum variance.
30 H, Hot?, Competitivepricepaths of an exhaustible resource

But either (20) or (21) holds if and on& if

lim Z(t;P*)=Z=. (22)

f-+Do

In fact, if (22) holds, then (20) and (21) hold trivially. Conversely suppose
that (22) does not hold. If lim,,,Z(t; P*) < z, then lim,,,Z(t)=
lim ,,,R(K(t;P*),P(t))=O. Since K(t)gK,>O,Vr>=O, by the second in-
equality in (5), (6) and (lo), we must have lim,,,P(r)= cc by the last tw_o
inequalities in (5). Thus neither (20) nor (21) holds. If lim,, ,Z(t; P*) > Z,
then the flow supply of the=resource is zero at any t > t(Z; P*). Thus
R(K(t; P*), P(t))= 0,Vt > t(Z; P*), which again implies that P(t)= co, VI
> t(?!; P*). Therefore, neither (20) nor (21) holds.
But even with (22), the uniqueneg question does not seem to have any
sweeping answer. For the case where Z is finite, the extraction cost is zero, and
the production function is Cobb-Douglas, it is known that a solution is unique
[Stiglitz (1974) and Dasgupta (1974)]. HereJ will take the case where a
backstop technology exists. Thus Z < cc and Z = co.
If a backstop technology exists, one could argue that since the whole stock
of the resource will become homogeneous and inexhaustible once Z is reached
(even though each molecule of the resource is still non-renewable), the royalty
price of the resource will be bid down to zero and thus

P(t) = G(Z), v’t~t(Z;P*). (23)

We will adopt this view and take (23) as our boundary condition.
Now regard Z (and not t) as the independent variable and consider a
solution K = K(Z) and P = P(Z) of the system of differential equations

dK
-=s F(K R(K p)) _ G(Z)
dZ (24)
R(K, P)

dP
-= (P - G(Z))&(K, R(K, P>)
dZ (25)
R(KP) ’

which satisfies K(0) = K, and P(Z) = G( 2). This is a typical two-point

boundary value problem and is known to have a unique solution if Z is not
large [see, e.g., Meyer (1973)].
Furthermore, it can be shown that P( .) satisfies

f’(Z) 2 G(Z), vzgo. (26)

 H. Hori, Competitivepricepaths of an exhawtible resource 31

To see (26) for Z 2 2, let F = P(Z) and let k(Z) be a solution to

dK
-=s
dZ
F(K R(K p)) _ G(Z)
R(K p> 1,
with the initial value of k( 2) = K(Z). Then h(Z) = p and _k(Z) are a
solut@_pair to (24) and (25) for Z 2 z with the initial value of P( 2) = P( 2)
and K(Z) = K(Z). Sinc:e a solution of such an initial value problem is unique,
it follows that P(Z) = P(Z) = P(%!),VZ 2 z. Since P(Z) = G(Z) and G(Z)
= G( z),VZ 2 2, it follows that P(Z) = G( Z),VZ 2 2, and therefore (26)
holds for all Z 2 2. Next suppose that P(Z) < G(Z), 32 < Z. Then dF’/dZ
< 0 by (25). Since G’(Z) > 0, VZ -C 2, it follows that

as long as P(Z) < G(Z) and Z -C2. But this implies that dp’/dZ cannot turn
positive as long as Z < Z, which is clearly inconsistent with P(Z) = G(z).
Thus (26) has to hold for Z < 2 also.
Using the solution functions K(Z) and P(Z) obtained above, define
another function t(Z) by t(Z)= /OzR(l?(S), P(S))-‘dS, and let Z(t) be its
inverse function. Then it is obvious that Z(t), K(t) = I?( Z(t)), and P(t) =
P(Z(t)) satisfy the differential equations (6), (7) and (13), the non-negativity
condition (lo), the boundary condition (23), and the initial conditions Z(0) = 0
and K(O)= K,. If Z(t), K(f) and Z’(t) satisfy (6), (7), (13), (lo), (23) and the
just specified initial conditions, let t(Z) be the inverse function of Z(t). Then
it is easy to see that K(Z) = K(t(Z)) and P(Z) = P(t(Z)) are a solution pair
of the two-point boundary value problem (24) and (25). Thus we have proved
that a competitive path with the boundary condition (23) exists and is unique if 2
is not too large.

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