SET-UP COSTS AND THEORY OF EXHAUSTIBLE RESOURCES

The opening of a mine may involve once-and-for-all 'set-up' costs of exploration, clearing, tunneling, training, equipping; and its closure once-and-for-all costs of dismantling and cleaning-up. Indeed such non-recurrent costs may dominate the fixed and variable flow costs of resource extraction. It is puzzling then that in the formal economic analysis of exhaustible resources, attention has been focussed on the latter to the almost complete neglect of the former. It is the purpose in the present note to repair this deficiency and, in particular, to set forth a generalized form of Hotelling's 'r per cent rule' for the behaviour over time of the expected marginal current net benefit (MNB) derived from extraction. The most important finding is that if set-up costs are present then, along an optimal path, MNB must increase not continuously and exponentially at the current rate of interest but in discontinuous saw-tooth fashion at an average rate less than the rate of interest.