Non-Renewable Resources and Oil Economics

Non-Renewable Resources

• Two types of natural resources exist: renewable and non-renewable
• Non-renewable resources, like oil, cannot be reproduced after the resource is depleted
• Renewable resources, such as forests, water, and fish, can be replenished but at a cost.

Oil as a Non-Renewable Resource

• Oil is a non-renewable resource
• Oil's supply decreases as it's consumed
• Price changes reflect the decrease in reserves unless a substitute or more reserves are found.
• Marginal cost of extracting oil is small compared to its price.
• The oil industry operates like an oligopoly (or operates in a way that looks like a monopoly)

Oil Price Determination

• Expected price increase is equivalent to oil's foregone interest rate.
• Percentage rise in oil price = (Expected Price Rise - Price of Last Year) / Price of Last Year
• The interest rate and the percentage rise in oil price are equal.
• Actual oil price deviations occur due to new reserve discoveries or political instability.
• Consumers reduce consumption as oil prices rise through efficient use (e.g., smaller cars).

The Commons Problem

• Commons are resources without an owner (e.g., air, wild fish, grazing land)
• Overuse of a common resource by its users often leads to depletion with users ignoring the consequences to others.

Efficient Allocation of Resources

• A benevolent dictator allocates resources to maximize total net social benefit by equating social benefit with social cost.
• The optimal number of cows to graze on common land that maximizes social welfare is 35.

Perfect Competition and Free Entry

• In perfect competition markets, there is no incentive for additional entrants or exits.
• Equilibrium profit is zero for economic profitability
• When a market is in long-run equilibrium under perfect competition, there is no incentive to enter or exit even when there is free entry.
• In a perfectly competitive market, marginal private revenue and marginal social benefit are equal to each other.
• Individuals in communities and markets driven by their self-interest will not likely lead to the optimal outcome.
• Government intervention to allow a free market in the provision of goods and services is required to maximize the common good.

Implications for Economic Policy

• Free entry leads to overgrazing and social loss
• Solutions to limit overgrazing include:
  • Government ownership and charging for resource use (e.g., a license fee).
  • Government regulation to restrict entry.
• The price of a license reflects the value of a common resource (e.g., grazing land, fish).

Renewable Resources: Fish

• Fish is a renewable resource
• Its growth depends on stock size
• Net growth is births minus deaths
• Sustainable yield is the maximum rate of harvest to keep the stock at a steady state.
• Beyond the sustainable yield, net growth is negative, stock declines, and risk of extinction occurs.
• Optimal harvest = Sustainable yield
• Social cost = private cost
• When there is perfect competition the fishing market leaves a low level of resources for future generations.

Efficient Allocation of Resources

• Efficient allocation maximizes total net social benefit by equalizing marginal social benefits to marginal social costs.
• Policies to ensure the efficient allocation of resources can include taxes, quotas, or permits.

Perfect Competition and Overfishing

• In a perfectly competitive market for fish, free entry and no restrictions on private marginal cost drive fish stocks towards extinction.
• The resulting equilibrium for perfect competition is inefficient (zero economic profit).
• No one wants to pay more for a license and the outcome is a depletion of the stock.

Policy Solutions

• Imposing a tax proportional to fish harvests restores efficiency.
• Create a system of licenses for individuals and companies to reduce overfishing.
• The optimal harvest maximizes sustainable economic profits for all.

Explore the concepts surrounding non-renewable resources, focusing primarily on oil. This quiz covers the differences between renewable and non-renewable resources, the economics of oil supply and price determination, and the industry's market structure. Test your understanding of these critical environmental and economic principles.