Question

For the increasing marginal-extraction-cost model of the allocation of a depletable resource, how would the ultimate cumulative amount taken out of the ground be affected by (a) an increase in the discount rate, (b) the extraction by a monopolistic, rather than a competitive, industry, and (c) a per-unit subsidy paid by the government for each unit of the abundant substitute used?

Short answer

Answer: (a) An increase in the discount rate would increase the incentive for the industry to extract resources today, increasing the amount of the depletable resource taken out of the ground. (b) A monopolistic industry may extract the depletable resource slower resulting in a lower ultimate cumulative amount compared to a competitive industry. (c) A per-unit subsidy for the abundant substitute would decrease the demand for the depletable resource, reducing the extraction rate and the amount of the resource taken out of the ground.

Step-by-step solution

Scenario (a): Increase in the Discount Rate

An increase in the discount rate means that the present value of future profits from extracting resources will be reduced. This will make extracting resources in the future less profitable compared to extracting resources today. Consequently, the incentive for the industry to extract resources today will increase, which will increase the amount of the depletable resource taken out of the ground.

Scenario (b): Monopolistic vs. Competitive Industry

In a competitive industry, firms will extract resources until the marginal cost of extraction equals the market price. In contrast, a monopolistic industry will produce a lower quantity of the good to maximize profits, resulting in a higher price than in a competitive market. This means that in a monopolistic setting, the extraction of the depletable resource may be slower due to less extraction at higher prices. Therefore, the ultimate cumulative amount of the depletable resource taken out of the ground may be lower in a monopolistic industry compared to a competitive industry.

Scenario (c): Per-unit Subsidy for Abundant Substitute

When the government provides a per-unit subsidy for each unit of the abundant substitute used, the price of the abundant substitute will decrease. This will make the abundant substitute more attractive to consumers compared to the depletable resource, resulting in a decrease in the demand for the depletable resource. Consequently, the extraction rate of the depletable resource may decrease, and less of the resource may be taken out of the ground. In conclusion, the ultimate cumulative amount of a depletable resource taken out of the ground can be affected by a variety of factors in the increasing marginal-extraction-cost model. Understanding how these factors interact with resource extraction is crucial for policymakers and industry stakeholders to sustainably manage and allocate scarce resources.

Key concepts

Discount Rate Impact on Resource Extraction

Understanding the relationship between the discount rate and resource extraction is fundamental for both companies and policymakers. When the discount rate increases, it effectively reduces the present value of future cash flows associated with extracting resources. Why does this matter? Imagine you are sitting on a pot of gold underground. If tomorrow's gold is worth significantly less than today's because of a higher discount rate, you're better off mining and selling it now.

This scenario propels industries to intensify extraction in the present, depleting the resource more quickly. The concept is akin to 'a bird in hand is worth two in the bush,' where future resources are those elusive birds in the bush, made less valuable by a higher discount rate. This incentive shift can lead to an uptick in current extraction rates, desiring to capitalize on today's higher-valued resources. It's essential to grasp this dynamic because it influences how resources are managed over time, affecting conservation efforts and long-term availability.

Monopolistic vs. Competitive Industry Extraction

The nature of the market structure plays a pivotal role in how resources are extracted and consumed. In a competitive market, multiple players are like eager beavers, each one working hard to extract and sell resources as long as the price covers the cost. They'll keep going until the profits are just a memory.

In contrast, a monopolistic firm acts more like a strategic chess player, carefully considering each move. It will extract less of the resource to maintain a higher price and secure greater profits, which often leads to a slower depletion rate. The monopolist's playbook aims to maximize profit, not the volume of sales.

This distinction matters to our environment and economy because in a competitive market, resources might be rapidly depleted, but in a monopolistic setup, the pace is typically slower, potentially allowing for more sustainable management of natural resources.

Subsidies Effect on Resource Depletion

Government policies, such as subsidies, significantly shape resource allocation and utilization. Introducing a subsidy for an abundant substitute decreases its price and increases its appeal, causing consumers to shift their preference away from the depletable resource.

For instance, if you're buying bread and suddenly breadsticks get cheaper because of a subsidy, you might switch to munching on breadsticks–similarly, industries switch resources, lowering the demand for the initial, now less competitive, resource.

This shift can slow down the extraction of the depletable resource, making the reserve last longer. It's a tool governments can use to steer consumption towards more sustainable options or to manage a depletable resource more conservatively. Understanding these mechanisms can help determine the effectiveness and impact of such subsidies on long-term resource conservation.