Set-up costs and the existence of competitive equilibrium when extraction capacity is limited

Although set-up costs are prevalent and substantial in natural resource extraction, it is known that a Walrasian competitive equilibrium cannot exist in simple extraction models with set-up costs. This paper demonstrates that this result is sensitive to the assumption of unlimited extraction capacity and derives sufficient conditions for existence. An equilibrium exists if extraction is limited such that each firm earns sufficient surplus to cover its set-up costs or if firms choose extraction capacity subject to non-increasing returns. The resulting competitive equilibrium price either grows at the rate of interest when total extraction is below industry capacity or is constant when industry capacity is fully utilized. In the equilibrium, identical deposits are opened simultaneously, and set-up costs for new deposits are incurred when the industry has excess capacity rather than-when capacity is fully utilized. (C) 2003 Elsevier Science (USA). All rights reserved.