The mineral economy: how prices and costs can falsely signal decreasing scarcity

Natural resource prices and costs of extraction have declined simultaneously with increasing quantities of extraction for a long time. In a Hotelling sense this indicates decreasing scarcity since low cost resources normally would be used first and quantities of extraction normally would decrease over time. The main reason for the trend being opposite to Hotelling characteristics is usually thought to be due to technological innovation. However, an alternative reason for decreasing costs and prices and increasing quantities of extraction may be due to Georgescu-Roegen's [Georgescu-Roegen, Nicholas, 1972. Energy and economic myth. In: Georgescu-Roegen, Nicholas (Ed.), Energy and Economic Myths: Institutional and Analytical Economic Essays. Published 1976, Pergamon Press, New York, pp. 3-36] concept of 'Bonanza' where there is only the appearance of decreasing scarcity. Norgaard's [Norgaard, R.B., 1990. Economic indicators of resource scarcity: a critical essay. J. Environ. Econ. Manage. 19(1), 19-25] 'Mayflower' problem can be used to model an alternative neo-classical approach to resource extraction and scarcity. In this pager, a model of resource exploration is developed where the explorer does not know total reserves of the resource base as he searches for and extracts the natural resource. The explorer never entirely knows how big the resource base is but does gain information about the potential location of new reserves as discovery proceeds. That reduces exploration costs. The lower exploration costs can cause the price to fall over time, until eventually scarcity of the resource causes the price to rise. The true scarcity is only revealed towards the end of exhaustion. The model shows that it is possible to have several years of increasing production simultaneous with lower prices and costs until a sudden, intense price rise occurs with a huge cut in production. When technology is able to cut costs and increase the reserve base, the decline in prices and costs and the increase in production can last longer. However, even with better technology, it is still possible for a sharp increase in price as long as demand is growing faster than technological innovation. The problem is that the true size of the resource base is never known. Society does not know if technology is actually overcoming scarcity or not until demand for a resource outstrips supplies. It is even possible for a price shock of incredible magnitude to surprise an economy within one or two years after a hundred years of declining prices and increasing production. (C) 1999 Elsevier Science B.V. All rights reserved.