Transcript Role of Economics

SECTION V
Applied Natural Resource Problems
Chapter 10
Mineral Economics
the reminder of the book: will survey specific
resource problems, employ simple tools of
economic analysis to clarify them, and point
toward their possible solution
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Minerals: Nonrenewable Resources (S1 = S0 – Q0)
• Inorganic solid substances that are found in or on
the ground and are used by humans
• Categories:
fuel minerals—coal, oil, natural gas
ores—iron, nickel…
metals
nonfuel minerals
precious metals—gold...
industrial minerals—natural
aggregate, cement, fertilizer
minerals, abrasives, and
gemstones
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1. Geological Factors and Costs of Extraction
• Figure 10-1, page 171
– As the mineral grade (mineral content per quantity
of material) decreases, known and expected
quantities of mineral increase
– As the grade decreases, the costs of extraction and
refining increase
– Two essential questions: the socially efficient rate at
which the deposit should be used up? the
economically efficient rate at which geological
exploration should be pursued?
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2. Extraction Economics for a Known Stock
• The two-period example: Present value of net
benefits (PVNB) = Net benefits in year 0 + [1/(1+r)]
(Net benefits in year 1)
• Solving for intertemporal efficiency means to
maximize PVNB, then:
 ( PVNB)
 ( PVNB)
d ( PVNB) 
dq0 
dq1  0
q0
q1
1
( p0  MC0 ) 
( p1  MC1 )( 1)  0
1 r
• P.173: the two output rates that give a maximum
PVNB are the rates where the change in this year’s
net benefits and the change in next year’s benefits
(discounted) are exactly offsetting
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1
p0  MC0 
( p1  MC1 )
1 r
Since r > 0, [1/(1+r)] < 1, so, (p1 – MC1) > (p0 – MC0).
See Figure 10-3, on page 174: q0 + q1 = 160 + 140 =
300.
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• Conclusion 1: q0 > q1
– The dynamically efficient production profile
involves a “tilt” toward the present, in the sense
that extraction in the first year exceeds that of the
second year
• Conclusion 2: (go back to slide 4) the resource
rent rises at the rate of discount r
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0  ( p0  MC0 ) 
( p1  MC1 )
1 r
1
( p0  MC0 ) 
( p1  MC1 )
1 r
1
rent 0 
rent1
1 r
rent1  (1  r )rent0
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• Conclusion 3: (go back to slide 4)
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user cost = – 1  r ( p1  MC1 )
Conclusion 4: price rises at the rate of discount r
over time, or, price is tilted toward the future—
this is the famous “Hotelling Rule”. The
assumption is that extraction cost and demand
functions are stable.
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The rule is derived from the work of
U.S. economist Harold Hotelling (18951973) in his paper “The Economics of
Exhaustible Resources” (Hotelling
1931), published in the Journal of
Political Economy. This paper has laid
the foundation for further research in
the field of non-renewable resource
economics.
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Question
 Let the inverse demand functions of the two periods be: p0 =
15 – q0 and p1 = 15 – q1. Let the marginal extraction costs
be MC0 = 5+q0 and MC1 = 5 + q1. p = MC in each period
occurs at q=5, so if the total quantity is 10 or more, there is
essentially no intertemporal problem, at least if our horizon
is limited strictly to two time periods. But suppose there is a
limitation, say q0 + q1 ≤ 8. A flat production profile would
have q0 = q1 = 4. But this cannot be efficient if there is a
positive discount rate. Suppose there is. Show the production
profile is tilted toward the present (use a 10% discount rate).
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3. Mineral Prices in Fact
• Figure 10-5, p.177: 9 minerals, 1902-1998, the US
• up-and-down movement, but overall drop in
prices
– The market simply does not see a quantitative
restriction in these resources in relevant human-scale
time frame
– Technical change along the whole continuum of
natural resource exploration, discovery, development,
extraction, transportation, and processing
• The recent upward swing in mineral prices since
2006 is the surging demand from developing
countries
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4. Resource Exploration and Development
• Exploration and development can increase the
inventory of known deposits
• Better exploration methods can make it possible
to extract resources of lower grades and thus to
expand reserves
• Figure 10-6, p.179: MC of expanding reserves;
demand for reserves
– Reductions in extraction costs (due to technological
changes) have occurred faster that demand increase,
driving prices down
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The shift of S is bigger than the shift of D:
S1
Price
S2
E'
E
D2
D1
Quantity
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5. Nonrenewable Resources and Sustainability
• How can nonrenewable resources (minerals) be
used in a sustainable fashion?
– we will eventually shift to a substitute resource of
greater abundance (like solar energy)
– Invest the resource rents earned from current
mineral extraction into physical capital (tractors,…)
and human capital
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6. U.S. Mineral Import Dependence and Other
Policy Issues
• Table 10-2, p.182: mineral imports as a percent
of consumption show the heavy dependence on
imports to supply domestic demands
• The 1872 Mining Law (still in effect)
– set up the claim and patent system so that
prospectors can fill claims on public land found to
contain economically significant mineral deposits
and convert it to private ownership at low prices
– Suggestion: levy a federal royalty—a tax of x percent
of the net value (price minus extraction costs) of a
mineral delivered to the processing plant
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