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Optimal resource extraction under stochastic terms of trade

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  • Behrens, Axel
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    Abstract

    This paper examines the case where a small open economy owns a stock of exhaustible resources like Chromium, Copper etc. which are not consumed domestically but exported. The resource earnings are used to import consumption goods. We will discuss the optimal production of this resource, when the terms of trade (faced by the country) follows an exogenous given time path that is subject to some stochastic fluctuations. It will come about that uncertainty concerning future values of the terms of trade affects the extraction dynamics for the following reasons. First, if the functions involved in the first-order conditions are nonlinear, the expected future value of these functions differs from a world of certainty. Consequently uncertainty has an impact on the behaviour of resource-exporting- countries. Note that this change in behaviour cannot be captured with certaintyequivalence. Second, if the costs of extraction exceed the gain from the resource use for some time due to stochastic fluctuations, the country can keep the resource in the ground but maintain the option of future extraction when depletion will become profitable again. So uncertainty creates an incentive to slow down production.

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    File URL: http://econstor.eu/bitstream/10419/46914/1/256011206.pdf
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    Bibliographic Info

    Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 395.

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    Date of creation: 1989
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    Handle: RePEc:kie:kieliw:395

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    1. John Hartwick, 1981. "Learning About and Exploiting Exhaustible Resource Deposits of Uncertain Size," Working Papers 456, Queen's University, Department of Economics.
    2. Lewis, Tracy R., 1977. "Attitudes towards risk and the optimal exploitation of an exhaustible resource," Journal of Environmental Economics and Management, Elsevier, vol. 4(2), pages 111-119, June.
    3. Glenn C. Loury, 1977. "The Optimal Exploitation of an Unknown Reserve," Discussion Papers 255, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    4. Gilbert, Richard J, 1979. "Optimal Depletion of an Uncertain Stock," Review of Economic Studies, Wiley Blackwell, vol. 46(1), pages 47-57, January.
    5. Pindyck, Robert S., 1980. "The optimal production of an exhaustible resource when price is exogenous and stochastic," Working papers 1162-80., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    6. Long, Ngo Van, 1975. "Resource extraction under the uncertainty about possible nationalization," Journal of Economic Theory, Elsevier, vol. 10(1), pages 42-53, February.
    7. Deshmukh, Sudhakar D & Pliska, Stanley R, 1983. "Optimal Consumption of a Nonrenewable Resource with Stochastic Discoveries and a Random Environment," Review of Economic Studies, Wiley Blackwell, vol. 50(3), pages 543-54, July.
    8. Deshmukh, Sudhakar D & Pliska, Stanley R, 1980. "Optimal Consumption and Exploration of Nonrenewable Resources under Uncertainty," Econometrica, Econometric Society, vol. 48(1), pages 177-200, January.
    9. Pindyck, Robert S, 1980. "Uncertainty and Exhaustible Resource Markets," Journal of Political Economy, University of Chicago Press, vol. 88(6), pages 1203-25, December.
    10. Arrow, Kenneth J. & Chang, Sheldon, 1982. "Optimal pricing, use, and exploration of uncertain natural resource stocks," Journal of Environmental Economics and Management, Elsevier, vol. 9(1), pages 1-10, March.
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