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Environmental Economics Assignment-2

The document critiques the Hotelling model, highlighting its sensitivity to interest rates, assumptions about time periods, oversimplified extraction costs, and the inability to account for unexpected increases in resource reserves. These factors complicate the model's applicability to real-world scenarios and suggest a need for refinement in resource economics analysis. The criticisms emphasize the importance of incorporating additional variables for a more accurate understanding of resource dynamics.

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17 views2 pages

Environmental Economics Assignment-2

The document critiques the Hotelling model, highlighting its sensitivity to interest rates, assumptions about time periods, oversimplified extraction costs, and the inability to account for unexpected increases in resource reserves. These factors complicate the model's applicability to real-world scenarios and suggest a need for refinement in resource economics analysis. The criticisms emphasize the importance of incorporating additional variables for a more accurate understanding of resource dynamics.

Uploaded by

shivu99pathania
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Environmental economics assignment

Asynchronus assignment

Answer) The passage outlines several criticisms of the Hotelling model, a fundamental
economic theory used to analyze the extraction and pricing of non-renewable resources. Here's
a breakdown of the criticisms presented:

1. Impact of Interest Rate: The Hotelling model's exponential nature makes it highly sensitive to
changes in interest rates. Gaugler's research highlights that adjustments to interest rates have a
significant effect on predicted resource prices. Additionally, Heal & Barrow's work suggests that
incorporating changes in interest rates improves predictive power compared to traditional
Hotelling-type models. However, empirical analyses have shown that while interest rates
change, resource prices may not always follow suit. This discrepancy poses challenges in
accurately applying the model, especially considering the difficulty in selecting an appropriate
interest rate for asset growth.

2. Time Period Considerations: Like interest rates, the chosen time period also greatly
influences resource prices according to the Hotelling model. Spiro's research emphasizes that
the model assumes constant time periods and continuously increasing prices, which may not
align with real-world dynamics. Finite time horizons, common among resource owners, can lead
to non-increasing resource prices and non-decreasing extraction rates in the long term,
potentially undermining the model's applicability.

3. Extraction Costs: Hotelling's model simplifies by assuming constant extraction costs,


neglecting the reality of increasing costs due to the progressive difficulty of extraction. Gaudet
suggests that easier and cheaper resources are extracted first, leading to rising extraction costs
over time. While technological advancements may offset some of these cost increases, they
introduce additional complexity to the model. Incorporating extraction costs into the analysis
becomes essential for a more accurate portrayal of resource dynamics.

4. Increasing Reserves: Hotelling's model assumes a known stock of resources, but in reality,
reserves can unexpectedly increase over time. This contradicts the model's premise and affects
resource pricing and depletion rates. The discovery of additional resources leads to price drops
and slower depletion rates, challenging the model's predictive capabilities.

In summary, the Hotelling model faces criticism regarding its sensitivity to interest rates,
assumptions about time periods, oversimplified treatment of extraction costs, and inability to
account for unexpected increases in reserves. These criticisms highlight the complexities and
limitations of applying the model to real-world scenarios, urging for further refinement and
consideration of additional factors in resource economics analysis.

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