Topics Today (4/4/13)  Continue from previous lecture  Marginal User Cost (MUC)  The Bet  Factors mitigating resource scarcity  Review of economics of nonrenewable resource use (in the context of Lecture 19 game)  HWK #7 on website, due next Tuesday  Office hours next week 2:30-3:30, 4:30-5:30 1Review of nonrenewable resource use: resource game 0.001.002.003.004.005.006.007.000 200 400 600 800Price ($) Quantity extracted Demand in current period (MB0) 2Review of nonrenewable resource use: resource game 0.001.002.003.004.005.006.007.000 200 400 600 800Price ($) Quantity extracted MB0PV_MB13Review of nonrenewable resource use: resource game Round P0 Discounted.P1 P1 Q0 Q11 2.45 3.25 4.55 582 3142 3.35 2.61 3.65 467 4293 2.90 2.93 4.10 525 3714 2.48 3.23 4.52 578 3185 2.56 3.17 4.44 568 328Observed3Prices3and3 Quantity33 in3Each3RoundQ* 522.67P* 2.92Equal3allocation:4480.001.002.003.004.005.006.007.000 100 200 300 400 500 600 700 800 900Price.($)Quantity.extractedMB0PV_MB1Round31Round32Round33Round34Round354Review of nonrenewable resource use  At what discount rate does equal allocation of the resource between the two periods apply? 0.001.002.003.004.005.006.007.000 200 400 600 800Price ($) Quantity extracted MB0PV_MB1When the discount rate is zero, creating a symmetrical marginal benefits across the two periods. 5Review of nonrenewable resource use  Graphically, what is the net present value of the mineral stock given efficient allocation of the stock? In other words, what is the benefit of the stock? 0.001.002.003.004.005.006.007.000 200 400 600 800Price ($) Quantity extracted MB0PV_MB1Green-shaded area 6Review of nonrenewable resource use  Graphically, what is the present value of total profit to the mine owners given efficient allocation of the stock? 0.001.002.003.004.005.006.007.000 200 400 600 800Price ($) Quantity extracted MB0PV_MB1Red-shaded area 7Review of nonrenewable resource use  At Q*, does it matter (in terms of profits) whether a mine owner changes his/her allocation by 1 unit? 0.001.002.003.004.005.006.007.000 200 400 600 800Price ($) Quantity extracted MB0PV_MB1Total3stock3extracted3in3period30price3in3the3first3periodprice3in3the3second3perioddiscounted3price3in3the3second3period525 2.90 4.10 2.93Extraction.in.period.0.(Q0)Profit0 14 0 20.511 7 1 20.482 12 2 20.453 27 3 20.414 35 4 20.385 17 5 20.356 8 6 20.327 20 7 20.29Total3participation: 140Total3extraction: 525Round33No! As can be seen in the graph at right from the game, at Q* the price in period 0 is the same as the discounted price in period 1 (i.e.,  VR LW GRHVQ¶W PDWWHU 7KLV LV also apparent from round 3, which generated a result very close to Q*; profits are virtually the same for all players in the game. 8Review of nonrenewable resource use  What is the marginal user cost of the stock in Round 1 of the game? 0.001.002.003.004.005.006.007.000 100 200 300 400 500 600 700 800 900Price.($)Quantity.extractedMB0PV_MB1Round31MUC Round P0 Discounted.P1 P1 Q0 Q11 2.45 3.25 4.55 582 314Observed3Prices3and3Quantity33in3Each3Round9Review of nonrenewable resource use  Graphically, what is the welfare loss from deviating from Q* in Round 1? 0.001.002.003.004.005.006.007.000 100 200 300 400 500 600 700 800 900Price.($)Quantity.extractedMB0PV_MB1Round3110Review of nonrenewable resource use  What is the marginal user cost of the stock in Round 2 of the game? 0.001.002.003.004.005.006.007.000 100 200 300 400 500 600 700 800 900Price.($)Quantity.extractedMB0PV_MB1Round32MUC Round P0 Discounted.P1 P1 Q0 Q12 3.35 2.61 3.65 467 429Observed3Prices3and3Quantity33in3Each3Round11Review of nonrenewable resource use 0.001.002.003.004.005.006.007.000 100 200 300 400 500 600 700 800 900Price.($)Quantity.extractedMB0PV_MB1Round32 Graphically, what is the welfare loss from deviating from Q* in Round 2? 12Review of nonrenewable resource use  If extraction costs in the future become cheaper due to technological advance, what will be the effect on extraction in the current period? A=Increase B=Decrease C=No change D=NIW Quantity $ MEC MC=MEC+MUC Q* P* Demand 3¶ 4¶ 0&¶ 0(&08&¶ 13 The logic is that a decrease in future extraction costs increases the marginal net benefit of the resource in the future, thereby increasing the opportunity cost of the marginal unit of stock extracted in the current period. If you have trouble seeing this with the current graph, try thinking about it with the standard 2-period graph.Review of nonrenewable resource use  If demand for the resource in the future becomes greater, what will be the effect on extraction in the current period? A=Increase B=Decrease C=No change D=NIW Quantity $ MEC MC=MEC+MUC Q* P* Demand 3¶ 4¶ 0&¶ 0(&08&¶ 14 The logic is that an increase in future demand (marginal benefit) increases the marginal net benefit of the resource in the future, thereby increasing the opportunity cost of the marginal unit of stock extracted in the current period. If you have trouble seeing this with the current graph, try thinking about it with the standard 2-period graph.Review of nonrenewable resource use  Which of the following sequences are consistent with standard economic theory of efficient extraction of a nonrenewable resource over time? Assume constant marginal extraction cost. Period30 Period31 Period32extraction 50 60 70undiscounted3price 30 33.0 36.3Period30 Period31 Period32extraction 50 45 40undiscounted3price 30 27.3 24.8Period30 Period31 Period32extraction 50 45 40undiscounted3price 30 33.0 36.3A=Yes B=No C=NIW  Which of the sequences are consistent with standard theory when marginal extraction costs increase as the resource stock falls? No different than above. Rising marginal extraction costs means that MUC increases faster over time, and so once again price will rise over time and extraction will fall over time 15 A=Yes B=No C=NIW A=Yes B=No