Resource Prices and Planning Horizons

60 Pages Posted: 3 Oct 2012

See all articles by Daniel Spiro

Daniel Spiro

Uppsala University, Dept. of Economics

Date Written: August 2012

Abstract

This paper shows that a seemingly simple assumption, regarding the time horizon of economic agents, may help explain the long run price dynamics of exhaustible resources such as oil, coal and metals. It does so by exploring a common observation, namely that economic agents have a progressive finite time horizon, meaning that they make a plan over a finite number of years but update this plan on a regular basis. This behavior can be observed in the business plans of firms, in US social security and in the extraction decisions of natural resource owners. Compared to an infinite horizon assumption, progressive finite time yields virtually identical results when used in a standard model of capital accumulation. However, when used in models of natural resources, this behavior has the effect of removing the scarcity consideration of resource owners, thus letting only operating costs and demand determine the extraction rate. This implies that extraction will be non-decreasing and resource prices non-increasing for a long period of time -- in line with the trends of a majority of exhaustible resources in the last century. Using data on how resource prices react to changes in resource stocks, the infinite horizon hypothesis cannot be supported while a time horizon of 28 years and less cannot be rejected. A calibration of the model to the oil market yields a price which closely fits the gradually falling real price after WWII and the sharply increasing price after 1998.

Keywords: Progressive finite time, Decision-making under uncertainty, Oil price, Resource extraction

JEL Classification: D81, D91, O40, Q31

Suggested Citation

Spiro, Daniel, Resource Prices and Planning Horizons (August 2012). Available at SSRN: https://ssrn.com/abstract=2155725 or http://dx.doi.org/10.2139/ssrn.2155725

Daniel Spiro (Contact Author)

Uppsala University, Dept. of Economics ( email )

Box 513
Uppsala, 751 20
Sweden

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