CCED Working Paper Series
Monopoly Extraction of an Exhaustible
Resource with Backstop
Min Wang
Abstract
When an exhaustible resource has a competitively supplied backstop with constant marginal cost and abundant supply, the resource price would continuously increase over time until the cost of the backstop and then stay flat there-after. In this paper, we show that, if the exhaustible resource is owned by a monopolist and the backstop has capacity constraints, i.e., the production of the backstop cannot supply the whole market when it becomes competitive, the traditional continuous price path for a resource does not hold. The resource price may continuously rise to the cost of the backstop and then the monopolist staves off the backstop for a while by keeping resource price flat. But eventually, the monopolist would reduce production dramatically, let the resource price jump above the cost of the backstop, which would produce at full capacity, and act as a monopolist off the residual demand. Our robust check shows that the discontinuous price path exists only when both monopoly and capacity constraints of the backstop are satisfied.
Monopoly Extraction of an Exhaustible Resource with Backstop.pdf
