Non-Renewable Resource Supply: Substitution Effect, Compensation Effect, and All That

Abstract

The resource literature has studied market and other equilibria extensively. Yet no systematic synthetic treatment of non-renewable resource supply has been provided. In this note, we examine the supply decision of individual resource suppliers facing given prices. We establish instantaneous restricted and unrestricted supply functions and de- compose the effect of a price change into an intertemporal substitution effect and a stock compensation effect. The later arises when the stock of reserves to be extracted is en- dogenous. We show that the substitution effect always dominates so that a price increase at some date always causes supply to decrease at all other dates. Thus, despite the for- mal resemblance of intertemporal resource supply theory with the theory of the demand for many goods, there is no phenomenon similar to the Giffen paradox in resource sup- ply. Among other clarifications brought about by this theory of non-renewable resource supply, it explains why the literature does not find exceptions to the green paradox. It also shows how to avoid supply aggregation problems that make several existing results questionable.

Keywords