Question

For the increasing marginal extraction cost model of the allocation of a depletable resources, how would the quantity consumed in the first period be affected by:

a. An increase in the discount rate

b. A per-unit tax on the depletable resource

c. A per-unit subsidy for each unit of the substitute resource that is used

Answer 1

SOLUTION:

• With increasing marginal extraction cost following will be the impact:

  a. Increase in discount rate will reduce the amount taken out of the ground since it will become more expensive to extract and hence there will be lower demand.

  b. Extraction in monopolistic industry will be lower than competitive industry because in monopoly the optimum quantity or profit maximisation quantity is MR = MC and in competition it is P = MC, where as quantity at MR = MC is lower than quantity at P = MC.

  c. A per unit tax on resource will also lower the extraction, since this will shift the supply curve to the left and hence lower equillibrium quantity will be there

  d. An increase in subsidy of subsitute product will also lead to lower instraction, since the demand curve will shift downwards for this commodity and hence there will be lower quantity produced / extracted.