The economics of Exhaustible Resources - Essay Example

The Economics of Exhaustible Resources Introduction Without a doubt, economists’ of exhaustible resources is based on the prediction of production and price trajectories and the likelihood of resources exhaustion. This is because; exhaustible resources have limited life span considering the optimal exploitation of resources at the both individual and industrial level. As a result, focus on Harold Hotelling explanation on maintenance of exhaustible resources is based on the importance of sustainability of a production–consumption system as a way of controlling extinction of exhaustible natural resource without getting comparative advantage from it as compared to its future demand. More considerably, it is important to establish whether it is viable to either extract or not the remaining exhaustible resources in the future considering the relevance of Harold Hotelling work in today’s world economic situation. More significantly, it is imperative for exploitation of non-renewable resource to be undertaken for the benefit of the people and a country’s economy considering the level of extinction and financial value derived. Considerably, it is essential to make decisions considering the economic models that focus on sustainable economic growth taking into account resource constraints. As a result, it is decisive to evaluate on whether or not it is viable to carry out exploration on the extent in which resource constraints can be overcome by substitution and technological change. More considerably, Hotelling’s theory was focused on the consideration of the prevalent consumer demand. Nonetheless, the influence of the extinction of natural non-renewable resources is focused on the current initial stock of the resource considering the amount of the resource to be extracted within different periods with the main aim being on the maximization of profits (Hotelling 139). However, it is difficult for a country to avoid exploiting its exhaustible resources especially when there is a high demand for the commodity. More so, it is essential to consider that non-renewable resources provide a comparative advantage because countries could be the sole producers of valuable non-renewable resources. As a result, such country’s take advantage of their monopolistic position in the resource market, as it lacks competition in the production of the exhaustible resources thus, positioning itself strategically in the world market (Martinet 17). In addition, a country makes a decision on price that the exhaustible resource would be sold as it gains competitive advantage, when negotiating for the prices being the sole producers of such extinct natural resources like oil. Thus, the duty of a government is to create ways in which the non-renewable resources can be sold in the world market resulting in a country getting a chance to exploit the non-renewable resources it has by using the best-suited strategies of price maximization. Although, exhaustible resources bring international trading to a country it also creates issues in terms of international development in the world. More so, exhaustible resources are predicted by production and price trajectories thus it becomes difficult for countries to make viable decisions considering the fact that the resources become scarce leading to increase in prices of non-renewable resources. However, such decisions of taking advantage of the prevailing high prices does not take into consideration the international development issues including effects resulting from the extinction of most of the natural resources that are in the risk of extinction because they are non-renewable (Solow & Wan 360). More significantly, the dominance in the monopolistic market of different natural resources have seen organizations that are establish by countries join to create a common stand in the provision of higher prices of the exhaustible resource they produce. For example, oil producing and exporting countries (OPEC) that deals with the oil production and prices using the monopoly power they have in selling the oil product in the World market. Even though, Harold Hotelling economics of exhaustible resource faces challenges in terms of its assumption, methodical and styles, it still has influence in the economics field considering his explanations on the outcome of extinction of such resources as prices change. More considerably, Hotelling seek to highlight the plight of laborers and subsidiary industries that deal with mining as soon as the natural non-renewable resources remain exhausted in the mine. As trends in the non-exhaustible, resources took an advanced turn in the economy, producers of non-renewable resources remained united and got more involved in predicting the future production and price trajectories, as they took consideration of resource exhaustion. More significantly, Robert Solow started to popularize Hollow’s theory in 1973 after the oil producing and exporting countries increased the oil prices in the world (Solow & Wan 360). As a result, more economists featured on expounding on the economics of non-renewable resources theory of Hotelling by illustrating the questions that arose of the adequacy of the natural resource in the period between1972 to 1981 over the conservation movement and theory of exploitation of non-renewable resources. Hotelling theory introduced new concepts based on the extinction of natural resources as he focused on the prevailing factors that he considered relevant in making decisions on whether extraction of such valuable resource was viable considering that they were non-renewable (Minnitt 539). More significantly, Hotelling emphasized that the changes in price levels acted as a useful indicator of scarcity especially as it describes how the non-renewable resource markets are functioning (Minnitt 539). In addition, the theory emphasized on the fact that extraction of resources should consider the market structure, as it mattered especially considering that the market was competitive or monopolistic. More considerably, the theory emphasized on the effects of exploration and technological innovation as it affects the extraction of natural resources as it had a lot of influence on mineral availability over time (Minnitt 539). The theory explains that non-renewable resources cannot be replaced because such minerals among other natural resources are not homogeneous. As a result, it is necessary for owners of the non-renewable resources to consider backstop technologies, as one that could limit the degree to which prices can increase in the market. More significantly, the prices of mineral resources are influenced by the respective changes in demand levels of the resource as per the availability in the market. Therefore, the theory describes substitution as an important response to increased scarcity, as prices of the non-renewable resource increases over time because of extinction of the resources(Minnitt 539). Detailed Summary on the Economics of Exhaustible Resources In most cases, viability of the non-renewable resource market system is influenced by a set of constraints that focus on a combination of guaranteed consumption within a specified period and the stock of resources that remains preserved at all times. Nonetheless, such an equitable perspective of existence of natural resources based on future market prediction does not exist. This is because the non-renewable resource market is faced by two grounds of uncertainty based on the behavior of exhaustible resource markets and uncertainty over the future demand for the resources before its depletion (Pindyck 1203). More significantly, the lack of uncertainty based on the amount of reserve base makes mining of such resources ultimately available as seen from increased exploitation of such resources. As a result, existence of such uncertainties causes a likelihood that the present reserves and demand of most exhaustible resource in the markets remain inherent because of the long-run dynamics involved in resource production. In addition, Hotelling had assumptions on the economics of exhaustible resources that he derived to explain the reason behind the need of controlling exhaustible resources exploitations. Nonetheless, some economists opposed to Hotelling’s theory found the assumptions he developed as economic perspectives that did not reflect the current real world of mineral extraction. Firstly, it is assumed that the owners of the mineral extraction aim at maximizing the current and future profits. This is because all people extracting exhaustible resources are faced with the same costs thus, operate in a perfectly competitive market (Stiglitz 657). More significantly, this assumption is attributed to the fact that exhaustion of non renewable resources remains dominant in competitive perfect market as the producers do not have power over the prices of the exhaustible resources produced. More so, the production of exhaustible resources is not constrained by existing capacity limits, because more or less quantities can be produced during the production period of the exhaustible resource. As a result, the exhaustible resource is considered to have a capitalized value. More considerably; the most expensive exhaustible resources are exploited first followed by others after exhaustion of such non-renewable resources that attract high levels of returns (Martinet 18). Furthermore, Hotelling assumed that the exhaustible resources are uniform in size and grade over their lifetime before they are finally become exhausted from the economy. Nonetheless, the theory assumed that the costs of the exhaustible resources are constant failing to meet the economic reality, as the prices of such valuable resources keep on changing as the exhaustible resources are exploited (Minnitt 540). This is because the more the exhaustible resources are depleted the more increased drilling costs as the existence of such non-renewable resources remained extinct. Finally, the theory is also based on the assumption that technology state remains constant and does not change as extraction takes place (Martinet 18). As a result, the theory assumes that there is no new additional technology used during the lifetime of the exhaustible resources. Although, the economics of exhaustible resources and the assumptions tend to diminish the value of exhaustible resources shows that it focuses on how the exhaustible resource behave in an economic way (Minnitt 540). More significantly, the Hotelling theory explains the existence of exhaustible resources based on the extraction costs as it focuses on the price per unit of the resource within the prevailing market condition of a certain class of economic resource. Moreover, the continuous use of Hotelling works is due to balance that was emphasized by Paul Bradley in 1985 focused on whether the economics of exhaustible resources had benefited the mining industry (Minnitt 541). Nonetheless, explanations given based on the issues were closely similar from those identified by Hotelling theory. This is because, Bradley also identifies the rising concept of sustaining exhaustible resources as it creates an urge to understand depletion rates, discount rates, and how markets are regulated to avoid extinction of the valuable non-renewable resources. More considerably, in the market of exhaustible resources it is clear that predictions of future prices are hard to be clearly stipulated using the current market trends. This is because, the producers who are the main dealers of such valuable resources can always forecast the current demand and reserves levels in the market even though, they do not know what demand and reserves levels will be like in the future market. Martinet explain that it is difficult to show that demand uncertainty would have little or no effect on the expected dynamics of market price of exhaustible resources (19). This is because the uncertainty levels of resources would only shift with the expected rate of change in prices considering the extraction costs that remain nonlinear to the reserve levels. On the other hand, the market conditions of exhaustible resources shift when the prevailing market demand function is nonlinear. This is because both the demand and reserve levels uncertainty affect the dynamics of production without taking into consideration the characteristics of extraction costs. More significantly, Hotelling model also extends to take into consideration exploration, as a means of reducing uncertainty in the non-renewable resource levels. In addition, the model gives an explanation on uncertainty of accumulating reserves depending on the future response of discoveries to exploratory effort. More significantly, as the existence of exhaustible resources becomes extinct in the world it has created a need for the regulation of extraction of exhaustible resources. The assumptions that Harold put in place was long back in the year1931 thus, this period remains long considering the current changes in the world today that have seen changes in economists’ perception. As a result, there has been increased demand for the theory review in order to make Hotelling’s theory just as any other theory used in the twenty first century to remain relevant towards protection of exhaustible resources that are in the world from extinction. As a result, different economists who have remained interested in theory have come up with ways of expounding on Harold Hotellings works on economic of exhaustible resources (Devarajan & Fisher 68). More so, the current economic adjustments with major changes especially in the mining sector as resources that are considered non-renewable that remain extinct have seen economists adapt to initial theories such as the Hotelling’s theory to give a decisive perception of the outcome of the availability of resources in the future. More especially, the assumption on the existent real inflation adjustments considering a risk-free interest rate on investments in the economy has seen increased levels of activities as prices of most natural resources that are considered important rise upward sharply. As a result, the owners of the exhaustible resources have been left with hard choices to market on whether they will extract the resource that they have in reserve now, or they will hold on to it for extraction in the future. This is because the dealers of exhaustible mineral resources expect that there will be a shortage in the level of resources available as the remaining portion are sold in the market, and because of this remaining resources will get high returns when there will be increased scarcity levels in the economy. More significantly, any amount of the available resources can be considered not be available in the future because any resource that is left untouched are more likely to fetch a higher price in the future. As explained by Hotelling, the use of the competitive advantage of increasing price levels remains significant, as resources become depleted and scarce causing prices to increase (Rowson 237). As a result, the current exhaustible resource market dealers base their decision-making on Hotelling, two fundamental factors as it influences their extraction decision even as they consider the increased levels of international developments in trade levels. More so, as the economics of exhaustible resources assist in the exploitation of extraction of resources it has been addressed by scholars and economist including Robert Solow who popularized its use in influencing extraction of exhaustible resources. He related Hotelling theory work based on how decisions are made based on the two fundamental factors that had influenced the extraction of the non-renewable resources especially oil. This is based on the existence of scarcity of non-renewable resources in 1972 as the Oil Petroleum, and Exporting countries (OPEC) increase the prices of oil. Moreover, it was clear that the action OPEC undertook was influenced by the importance of price in determining the scarcity of non-renewable resources in a stable market that operated normally. In addition, their decision was also based on Hotelling assumption that exhaustible resources would even have higher prices considering the fact that before the oil demand levels increased the prices were low. However, the changes later on undertook a shift in oil market prices as the levels of oil extracted went high leading to higher levels of depletion that eventually led to the increased scarcity levels. Nonetheless, the existence of scarcity of oil as a natural resource that is non-renewable created opportunity costs. As a result, the existence of opportunity cost made the owners and dealers of oil product devise ways of allocating the non-renewable resources that are available. As a result, the increased levels of scarcity that was inflicted by increased exploration prospects, led to the fluctuation of the price as OPEC changes the prices at different times this enhanced influence of more likely monopolistic market. In addition, the market in which the non-renewable resource is currently operating in portrays characteristics of either monopoly or competitive markets. This is because, it is more of a monopoly as the exhaustible resources are only produced by one country and consumers lack another source of supply of such a renewable resource. While on the other hand, the exhaustible resources operate in the competitive market where there is increased supply in the market as many countries have accessibility to the resource. More significantly, the monopoly price determines the production rate of the non-renewable resources a country as it is the producer who fixes the price (Hotelling 139). However, Hotelling speculated that monopoly prices would remain constant for a longer period as it would rise higher at a slower rate than the prices at competitive market. Furthermore, Hotelling implied in his assumptions that the competitors have the same costs and are in a perfect market with immediate availability of resources and ready market. In addition, countries that have the same non-renewable product may join and collude to set the production level and prices of the non-renewable resource. For example, is the organization of oil producing and exporting countries (OPEC) that was formed by those members who came together and set the prices of oil in the world. More so, the limit of backstop technology on increasing prices in the economy and the concept of such technology provides an explanation for the reason why the prices of such non-renewable resources rise at a point when cost of technology is competitive and is relevant to the global energy market. Thus, backstop technology provides a ceiling price for the exhaustible resources in the economy especially when there are several producers in a competitive market (Pindyck 1204). In addition, when non-renewable resource reaches ceiling level it is priced out of the market allowing the competitive resource to be used at a price above the regulated levels especially in cases of scarcity. However, backstop technology is not only based on renewable resource but can also be used in non renewable resources such as coal-based electric Hauling as it would be a non-renewable backstop for fixed petroleum resources (Hotelling 142). In addition, there exist influences of uncertainty in nonrenewable resources estimates on the economy. Hotelling examined a question of uncertainty of nonrenewable estimates in the economy as he considered the reason as to why prices would not be predictable based on current stock levels. However, when the economy is in a good position, it is necessary to analyses matters that had arisen like the value of exhaustible resources, when the content of available resource is known and the approximation of what it holds (Pindyck 1205). As a result, considering the analysis results if the amount of the exhaustible resource discovered is higher there will be a low price for the non-renewable resources that have been explored. However, the entry reserve after discovery, which will have higher prices after exploration due to the optimism of the future prospect of the non-renewable resource. Conclusion Therefore, it is imperative to establish the impact rule on the extraction of exhaustible resources in the economy. Hotelling rule assumes that real inflation adjusted levels and risk-free interest rates of investments in the economy influence the extraction and prices of the natural resource in the economy. Furthermore, the Hotelling’s rule assists the owners of the exhaustible resources to make decisions to either extract the available resource now or in the future. If the owners feels that the price would rise, then the expected price rates will rise in the future they may opt to forgo the interest that they could have earned at the current prices and get higher income. In addition, Hotteling rule ensures the rule says that profits are maximized in every period if the prevailing reserve levels of exhaustible resources remain the same in all times especially considering reserves held for speculation. More significant, it is important to analyses impact of cost production on prices of non-renewable resources in the economy. In a case, where the costs of extraction increases and demand for the exhaustible resource fall there will be a loss as the shifts in the market lead to decrease in the prices. Also, when discover exhaustible resource price levels falls due to the uncertainty nature, its prices will increase eventually as extraction continues. Hotelling noted that profits will rise according to the rate of production of the owner of the exhaustible resources. Also, it is important to understand that the cost of production increases according to the depth of non renewable resource leading to increasing prices of resources to cater for the cost incurred during production. In addition, the price of exhaustible resource grows much faster as compared to the interest rate in an economy. As a result, there is a significant difference in the mineral deposit value as it rises from the beginning of potential extraction while sales depend on the capital asset of the owner of the non-renewable resource. More considerably, Hotelling theory introduced new concepts based on the extinction of natural resources based on the prevailing factors that he considered relevant in making a decision on whether to extract such valuable resource was viable considering that they were non-renewable. Without a doubt, it is relevant that, Hotelling emphasized on the changes in price levels as it acted as a useful indicator of scarcity especially as it describes whether the non-renewable resource markets are functioning well. Indeed, it is essential to understand that the theory emphasized on the effects of exploration and technological innovation as it affects the extraction of natural resources. More significantly, the theory, explains clearly that non-renewable resources cannot be replaced as they remain non-homogeneous and irreplaceable. More considerably, it is necessary for owners of the non-renewable resources to focus on the Hottelling theory to influence the availability of non-renewable resources. More significantly, the prices of mineral resources will be influenced by the respective changes in demand levels of the resource as per the availability in the market. References Devarajan, Shantayanan and Fisher, Anthony. Hotelling’s “Economics of Exhaustible Resources”: Fifty Years Later. Journal of Economic Literature, 19(1): 65-73. 1981. Hotelling, Harold. The Economics of Exhaustible Resources. The Journal of Political Economy, 39. (2) :137-175, 1931. Martinet Vincent. Sustainability of an economy with an exhaustible Resource: A viable control approach. Resource and Energy Economics, 29 :17–39 , 2007. Minnitt, RCA. Frontiers of usefulness: The economics of exhaustible resources The Journal of The Southern African Institute of Mining and Metallurgy, 107: 539-555. 2007. Pindyck, Robert. Uncertainty and Exhaustible Resource Markets. The Journal of Political Economy,88 ( 6) :1203-1225, 1980. Rowson, Peter. The International Tine Agreements: Price stabilisation in action. P. Crowson, ASTRIDE MINING, Issues and Policies for the Minerals Industry. Mining Journal Books Ltd, London, 287, 2003. Solow, Robert and Wan, Frederic. Extraction costs in the theory of exhaustible resources. Bell Journal of Economics, Management. Science. 7 (2) : 359–370. 1976. Stiglitz, Joseph. Monopoly and the Rate of Extraction of Exhaustible Resources. American Economic Review, 66(4): 655-661.1976. Read More