Class 4: resources, reserves, hotelling

Question 1

examples of natural resources

Answer 1

minerals, wood, fossil fuels, solar radiation

Question 2

what are environmental amenities?

Answer 2

characteristics of environment that benefit people directly, without having to be extracted and sold by a firm, like clean air, nice views, day at the beach

Question 3

what is a waste sink?

Answer 3

a natural part of the environment that captures pollution, like how trees or the ocean absorb/take in CO2

Question 4

what are the two types of natural resources?

Answer 4

stock: current usage affects future availability (like minerals, fossil fuels)
flow: current usage doesn’t impact future availability (like solar rays, wind)

Question 5

what are the two types of stock resources?

Answer 5

renewable: resource can reproduce, e.g. wood)
non-renewable: resource cannot reproduce (in a certain time frame, like in the next million years), two types are minerals and fuels

Question 6

how do economists vs ecologists view pollution?

Answer 6

economists: stock resource with a negative impact (a “bad” rather than a good), polluting activities increase stock and natural decay decreases it
ecologists: flow resource that affects environment, there is a natural capacity that environment can handle, once crossed pollution begins

Question 7

what does recycling do?

Answer 7

reduces demand for natural resources and waste sink

Question 8

material balance model

Answer 8

picture in word!

Question 9

what is the goal of sustainability?

Answer 9

alleviate poverty without negatively affecting future economic prospects

Question 10

what is the sustainable welfare level?

Answer 10

the welfare level of the population (determined by consumption) at which it is possible for future generations to have the same welfare

Question 11

weak vs strong sustainability

Answer 11

weak: sum of all capital (natural and human made) shall not decline over time
strong: natural capital shall not decline over time

Question 12

problems with weak sustainability

Answer 12

to what degree can natural capital be replace by human capital? very objective

Question 13

relationship between human and natural capital on a graph

Answer 13

welfare curves of society, like indifference curves
if perfect substitutes, straight line
if not substitutable, 90 degree bent line
somewhere in between: Cobb Douglas indifference curves

Question 14

Hartwick rule

Answer 14

weak sustainability
how much investment in human-made capital is necessary to make up for the loss in natural capital being used up, so the sum can stay constant over time

Question 15

Kuznets curve

Answer 15

relationship between GDP and pollution
inverted u-curve, if GDP starts low and increases pollution rises, eventually people are rich enough that if GDP further rises they care about environment, lower pollution
empirical evidence is mixed

Question 16

implication if Kuznets curve holds

Answer 16

if it holds, economic growth is good for the environment

Question 17

“limits to growth” idea

Answer 17

population, industry and pollution growth will hit a peak naturally and start to decline, even without political intervention
idea: speeding up the process is possible and necessary

Question 18

historically, when did the world start to worry about energy/resource economics?

Answer 18

in 1970s, oil crises prompted founding of IEA, US started making strategic oil reserves to balance prices

Question 19

stock function of a non-renewable natural resource (like minerals from a mountain)

Answer 19

S(t+1) = S(t) - R(t)
stock in year t+1 = stock in year t - extraction in year t

Question 20

stock function of a renewable natural resource (like wood from a forest)

Answer 20

X(t+1) = X(t) - H(t) + F(X(t))
stock in year t+1 = stock in year t - harvest in year t + growth of stock in year t

Question 21

resources vs reserves

Answer 21

resources is everything
reserves is what is technologically and economically feasible to extract

Question 22

what increases reserves and resources?

Answer 22

resources can’t be increased, because they include the resources we aren’t aware of/can’t use (yet)
reserves increase when new tech makes getting them cheaper (economically feasible) or physically possible, or when demand/prices increase

Question 23

Hubbert peak theory

Answer 23

discoveries of oil resources start off little, then the discovery rate increases due to tech and lower costs, until most resources are found and it begins to decline again bell shaped curve
prediction: peak oil in US in 70s (true), globally in 2000 (wrong so far)

Question 24

what is hotelling?

Answer 24

optimal resource extraction strategies by firms based on prices now and in future

Question 25

how does interest rate affect firms’ extraction of resources?

Answer 25

high interest rate: extraction now more profitable
π(t+1) < π(t) * (1+i)
low interest rate: waiting to extract more profitable
π(t+1) > π(t) + (1+i)

Question 26

when is there an equilibrium regarding extraction?

Answer 26

when firms are indifferent between extracting now and later
profit later = profit now times the interest rate 1+i

Question 27

Hotelling rule

Answer 27

p(t) = c + λ (1+i)^t

Question 28

What does the hotelling rule imply if interest is high/low? What about if t is high? What is λ exactly?

Answer 28

If i is high, price is higher.
If t is high, price is higher, so price increases over time.
λ is the capacity rent, a multiplicator showing by how much firms can mark up their prices over marginal costs.

Question 29

if λ is high, what does that say about competition in an industry? when is λ high?

Answer 29

If capacity λ is high, prices will be marked up higher over marginal costs. This means firms within the industry face lower competition, otherwise consumers would switch to another product. λ is high when there aren’t many alternatives/substitutes.

Question 30

what is a backstop technology?

Answer 30

A technology that serves as an alternative for an energy source (e.g. coal for oil). If price of oil increases too much, customers will switch to coal instead because it is now relatively cheaper.

Question 31

What is p(sub) and what happens if p reaches p(sub)? How should firms respond?

Answer 31

p(sub) is the price of the backstop technology, sub stands for substitute
Once price of energy source (like oil) passes p(sub), customers will switch to the alternative. Therefore, if p reaches p(sub), firms will maximize profit by extracting and selling all of their product.

Question 32

If interest is low vs high vs infinite, how does that affect the initial prices, the price pattern over the years, and the amount of years firms will extract resources for (T)?

Answer 32

graph in word!!!
Low i: higher initial prices, growth of prices slow, extraction takes longer
High i: lower initial prices, prices rise faster, extraction happens quickly (lower T)
Infinite i: constant low initial price until T is reached, jump up to p(sub), constant high extraction until T

Question 33

What is the self-fulfilling prophecy regarding oil extraction and prices?

Answer 33

If firms expect prices to rise, they wait to extract, which causes a supply shortage, which causes prices to rise

Question 34

What is the social discount rate r?

Answer 34

the rate at which the extraction of resources damages the population (through pollution or less resources for future generations)

Question 35

What does a high r mean? What would be the best r from a societal and corporate perspective?

Answer 35

A high r means society is more damaged by extraction.
If r is equal to interest rate, then the profit-maximizing corporate extraction and price also optimizes social welfare.

Question 36

In Hotelling model, resource extraction is optimal. What are some real-life factors that can get in the way?

Answer 36

Extraction too low: market power, firms withhold production to artificially induce shortage and increase prices
Extraction too high: higher i than r, state control of resources so usual price incentives not in place
The usual market distortions (products aren’t the same, asymm. information, etc.)

Question 37

Which RES are stock vs flow?

Answer 37

Stock: biomass (wood, manure)
Flow: geothermal, hydro, wind, solar (most RES)

Question 38

Which factors affect how much of flow RES are used?

Answer 38

Operation costs, availability of/investment in materials necessary to use energy (solar panels, batteries, wind mills, etc.)