In this paper, we review this “Hotelling puzzle” and suggest modifications to current theory that The prices of exhaustible resources—oil, natural gas, copper, coal, etc. . Review of Economics and Statistics 92 (2), Oil is an exhaustible resource. The economics of exhaustible resources is expressed through Hotelling’s rule. Hotelling’s rule states that the. Hotelling’s rule defines the net price path as a function of time while maximizing economic rent in the time of fully extracting a non-renewable natural resource. ” Hotelling’s ‘Economics of Exhaustible Resources’: Fifty Years Later”. Journal of.
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InHarold Hotellingan American economist has published an article with rresources “The economics of exhaustible resources”, which findings serve as a basic theory for economics of non-renewable resources.
His theory is fundamental in two aspects: Since this theory is valid only under several restricting conditions, which are not realistic in the real world, the validity of his finding were debated several times, especially in the s. However, if we gradually resolve these restrictions, we can get interesting conclusions that have important meaning for mineral industry.
Analysis of Harold Hotelling’s Theory – The WritePass Journal : The WritePass Journal
The Hotelling rule presumes the validity of the following conditions for the examined period: Hotelling’s article pointed out that economic behaviour of mining firms differs from behaviour of other industrial sectors. According to the basic theory of micro-economics, a competitive and profit-maximizing firm will rise his output until his marginal cost reaches the market price:.
The firm should reach a price for the product that the cost of the last unit of the product will be recovered.
If each portions of the product has the same price, then the price equals the marginal cost of the product.
The Economics of Exhaustible Resources
Hotelling has shown that since the quantity of the resource is limited exhaustiblewe should consider that the resource extracted exhxustible consumed today will be not available for future generations. Therefore during the evaluation of the currently extracted resource, that value should also be considered that would have been reached if the resource would be extracted in the future.
This future value, which is lost due to extracting the resource today is called as the opportunity cost. According to Hotelling, the opportunity cost is the discounted present value of the future profit which will be lost due to extracting the resource in the present.
Hotelling’s rule – Wikipedia
Therefore a competitive mining firm will rise its production until its marginal production cost and the opportunity cost reaches the market price:. Lets return to the figure exhaustibe in the lesson about the Ricardian rent. The firm, extracting mine G at the marginal production cost, will be competitive only, if the market price covers its production costs and exhxustible opportunity cost see figure 1.
The opportunity cost has different names: Hotelling rent, scarcity rent, user cost, royalty. Due to this variety of terms, several times it was misinterpreted.
Pierce and Turner, Otto et al. Therefore the user cost expresses a real cost, however it is a cost that appears in the future. The user cost has at least two important properties. First, the user cost is the net present value of the future profit for the mine producing at the marginal production cost, which will be lost if it will extract an addition unit of mineral rwsources of leaving it in the ground. For mines that produce at less production costs mines A – F in figure 1 the net present value of the lost future profit includes the user cost and the Ricardian rent, too.
Hotelling’s “Economics of Exhaustible Resources”: Fifty Years Later
Other important meaning of the user cost is that it expresses the in situ value of the resource, the fconomics of the resource before the extraction for the mine producing at the marginal production cost. This is derived form the fact that the resource is non-renewable. If this condition holds, then it is indifferent for the owner of the resource that it will be extracted now and sold at price P 0or will be extracted at any time in the future and sold at price P t.
The increase of nominal price of the resource by the Hotelling rule takes place until the exhaustion of the resource.
In the optimal case, the demand for the resource will cease due to its high price when the substitution backstop technology becomes hoteling and can replace the original resource. If there is still unsatisfied demand for the resource in the time of its exhaustion, it means that the price was not optimal, it could not fulfil the function to regulate the behaviour of consumers, or the backstop technology is still not available.
Representation of the Hotelling rent user resourcea and the Ricardian rent. The Hotelling rent and the Hotelling rule 1. According to the basic theory of micro-economics, a competitive and profit-maximizing firm will rise his output until his marginal cost reaches the market price: Therefore a competitive mining firm will rise its production until its marginal production cost and the opportunity cost reaches the market price: After Otto Other important meaning of the user cost is that it expresses the in situ value of the resource, the value of the resource before the extraction for the mine producing at the marginal production cost.