The Hotelling Model with Multiple Demands

Abstract

The purpose of this chapter is to provide an elementary introduction to the nonrenewable resource model with multiple demand curves. The theoretical literature following Hotelling (1931) assumed that all energy needs are satisfied by one type of resource (e.g. "oil"), extractible at different per-unit costs. This formulation implicitly assumes that all users are the same distance from each resource pool, that all users are subject to the same regulations, and that motorist users can switch as easily from liquid fossil fuels to coal as electric utilities can. These assumptions imply, as Herfindahl (1967) showed, that in competitive equilibrium all users will exhaust a lower cost resource completely before beginning to extract a higher cost resource: simultaneous extraction of different grades of oil or of oil and coal should never occur. In trying to apply the single-demand curve model during the last twenty years, several teams of authors have independently found a need to generalize it to account for users differing in their (1) location, (2) regulatory environment, or (3) resource needs. Each research team found that Herfindahl's strong, unrealistic conclusion disappears in the generalized model; in its place, a weaker Herfindahl result emerges. Since each research team focussed on a different application, however, it has not always been clear that everyone has been describing the same generalized model. Our goal is to integrate the findings of these teams and to exposit the generalized model in a form which is easily accessible.

Oil Trade and Climate Policy

“…In a recent article, Mityakov, Tang, and Tsui (2013) show that U.S. oil imports are significantly affected by international politics and American firms diversify their oil imports significantly away from political opponents of the United States. Another prominent explanation for the observed behavior of oil importers is related to the short and medium-run technological constraints which introduce imperfect substitution among oil products across different sources as in Salant and Gaudet (2014). Given these rationales and the sizable variation in oil prices which can not be explained solely by transportation costs or time-invariant exporter or importer characteristics, we employ the usual "Armington" assumption that goods are differentiated with respect to the origin which yields the following CES demand schedule:…”