c19f - Otherwise nothing would be conserved, but only...

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19.f. Exhaustible Resources Everyone lives for 2 periods: 0 and 1. The total amount of oil (Q) available for the two periods is QT. The demand in period 0 is D0, and D1 in period 1. Assuming R=10%, the present value (PV) of D1 is 10% below D1. The present value of both periods’ demands is the horizontal sum of D0+PV(D1). The intersection of this demand with supply S gives the price P0. This price must be equal to PV(D1)--otherwise it would pay to increase sales in whichever period has the higher price. Given the price P0, people who want oil today will buy Q0. People who want oil for period 1 will buy Q1. The price P0 is the price next year’s people pay to set aside oil for period 1. The quantities Q0 and Q1 add up to QT--The oil is exactly used up in the two periods. If there were a third period, and if the PV of what people were willing to pay in that period were above P0, then some oil would be conserved for that period.
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Unformatted text preview: Otherwise nothing would be conserved, but only because the third period people didn’t value the oil enough to make it worth conserving. Returning to the two-period world, suppose that the government decides that the free market is not conserving enough oil, and it forces people to consume only Q0’ in period 0. This would cause a loss equal to the right shaded area. The conserved oil becomes available for period 1, and period 1 people can increase their consumption from Q1 to Q1’, but the resulting gain (left shaded area) is smaller than the loss. Conclusion: The market automatically conserves resources at an optimal rate, so that we only run out of resources if it’s in our economic interest to run out. Forced conservation of any good (through recycling, mileage requirements for cars, etc.) only wastes resources....
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This note was uploaded on 09/25/2008 for the course ECON 160 taught by Professor Baim during the Summer '98 term at UCLA.

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