Lecture: Additional topics on non-renewable resources. 6 (a) In the context of a

Question

Lecture: Additional topics on non-renewable resources. 6 (a) In the context of a non-renewable energy resource, what is a “backstop” technology? 3 (b) How might the existence of a backstop technology for generating energy affect the price today of oil? (c) A profit maximizing, price-taking firm owns two deposits of copper, where the potential amount of copper in the deposits are the same but one is located at a shallower depth and has a lower cost of extraction. How should it exploit those two resources? Should it extract some copper from each deposit every year, or should it do something different? Describe the extraction strategy it should employ, and the underlying economic rationale. (d) If an industry owning a non-renewable resource acts monopolistically, how does the time pattern of resource price, pt, differ from what happens when the industry acts as a price-taking, competitive industry? How does the time pattern of extraction, yt, differ? What about the date when all of the resource has been extracted – does that differ? How about the total discounted present value of profit to the industry over the life of the resource – does that differ? (e) Has the world price of oil risen, from 2005 to now, approximately at the interest rate, as a simple version of the Hotelling rule would suggest? If not, how has it changed between, say (i) 2005 and 2012, and (ii) 2014 and today? What explains this?

Explanation / Answer

(a) Backstop technology is a technology that is able to produce a substitute resource to the non renewable energy resources. This technology uses the abundant inputs of production to preserve the exhaustible resources and availability of the alternation resources keeps the production cost at low level.

(b) Oil is a non renewable energy, which has close substitutes. As an example it can be stated that Cuba increased their production of sugarcane ethanol when crude oil import reduced during the fall down of Soviet Union. Therefore, increasing use of alternative resources would reduce the demand for crude oil and as a result, price of oil is likely to fall.

c) A profit maximizing firm always wants to maximise profits subject to a cost constraint. Profit can be maximised by either increasing revenue or reducing cost. As total amount of deposits are fixed, total quantity supplied by the firm is fixed. The optimal strategy for the firm would be extraction of copper from the deposits located at the shallower depth to minimize the cost. Or in the other words, the firm can extract the amount of copper from each deposit equating the marginal revenue with respective marginal cost of extraction. Low cost would help to keep price lower to maximise profit.

(d) Initially, monopolistic firm charges higher price for non renewable resource supply compared to a competitive firm. A monopolistic firm charges price equating with average revenue, which is greater than its marginal cost. On the contrary, a competitive firm charges price at the level P = MC.

When the non renewable resources are exploited efficiently to empty the stock, the change in percentage of net price per unit of time would be equal to the discount rate. This criterion would be useful to maximise the present value of profit on resource extraction.

P/(t)/P(t) = , where P(t) is the per unit profit at the time t.

Related Questions

Navigate

• Browse (All)
• Browse L
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.