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"), extractable 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 Herndahl (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 Herndahl's strong, unrealistic conclusion disappears in the generalized model; in its place, a weaker Herndahl result emerges. Since each research team focused 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.