Strategic Resource Extraction and Substitute Development
CentER Discussion Paper Series No. 3012-014
19 Pages Posted: 5 Mar 2013
Date Written: February 27, 2013
Abstract
We analyze a dynamic game between a buyer and a seller of an exhaustible resource. The seller chooses resource supply; the buyer can pay a fixed cost to invent a perfect substitute for the resource at any time. In closed-loop equilibrium, the buyer adopts the substitute when the resource is exhausted. Investing makes the buyer worse off because it decreases resource supply, destroys his ability to derive surplus from the resource through delaying the investment cost incurrence, and causes a larger share of the resource stock to be sold at his reservation price. From the seller’s perspective, the buyer’s ability to develop a substitute is equivalent to an already available substitute with a higher marginal cost.
Keywords: exhaustible resource, substitute, innovation, closed-loop equilibrium
JEL Classification: O30, Q30
Suggested Citation: Suggested Citation