The Hotelling pricing rule
Hotelling rule has been a pillar in support for nonrenewable economics that tries to relate long run behavior of pricing natural resources and extraction of resources. Economic theory of relative prices is another model that relates prices of nonrenewable natural resources and extraction. Hotelling rule predicts that prices of nonrenewable resources increase at an exponential rate that equals exchange rate (Lars, 22). A mineral deposit in the soil is considered to a bond an in other aspects it is interchangeable with such a financial paper.
Hotelling rule was developed by Harold in the article Economics of Exhaustible Resources. The rule interprets the economic law of demand and supply that states when the demand is high and supply is low price of the commodity rises. In this aspect of nonrenewable resources, when the resources are extracted, they become scarce and this calls for rise in price. Price of exhaustible resources is not identical to neighboring costs or extraction costs as is defined by a model of complete competition.
Nonrenewable resources such as oil and minerals are usually extracted fast because of their value. This means that the owner of such resources will only leave nonrenewable resources in the soil if the value of such resources is considered to increase over a given period of time with market interest rate. A small change in value of nonrenewable resources would promote increase in market interest rate resulting to scarceness of the commodity (Beckwith, 14). This results to what economics call scarceness pension which is an indication of promotion in additional unit of a resource.
Development of scarceness pension with market interest rate is called Hotelling rule. Many economic models in nonrenewable resources economics are usually based on this rule. Nonrenewable resources are always available in small and limited quantities. This means that the usage of such resources should be done in a proper and appropriate means so as to avoid wastage. Any period in which nonrenewable resources are used it results to consumption of resources leading to diminishment.
Hotelling rule and economic theory of relative prices may not suggest a fixed price for ever increasing non-renewable resources. The Hotelling rule takes interest rate as is given when the resource sector is considered to be in isolation. In this instance, critical information is lost because interaction between marginal productivity of capital and nonrenewable resources is not considered. The main reason that will lead to increase in price for nonrenewable resources is the level of extraction and marginal productivity of capital (Houston, 61).
Marginal productivity of capital will definitely decrease as a result of change in resource extraction. The extraction process of nonrenewable resources is dominated by decrease in the percentage change in capital. This means that the rental rate in respect to extraction of nonrenewable resources will decrease. Consequently, the price of nonrenewable resources will decline because as per Hotelling rule, the rate of increase in nonrenewable resource price does not deviate from real interest rate.