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Chapter 10 Applications to Natural Resources Objective: Optimal management and utilization of natural resources. Two kinds of natural resource models: (i)renewable resources such as fish, food, timber,etc., Section 10.2: an optimal forest thinning model. (ii)nonrenewable or exhaustible resources such as petroleum, minerals, etc. Section 10.3: an exhaustible resource model.

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10.1 The Sole Owner Fishery Resource Model 10.1.1 The Dynamics of Fishery Model Notation and terminology is due to Clark (1976): = the discount rate, x(t) = the biomass of fish population at time t, g(x) = the natural growth function, u(t) = the rate of fishing effort at time t ; 0 u U, q = the catchability coefficient, p = the unit price of landed fish, c = the unit cost of effort.

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Assume growth function g is differentiable and concave, where X denotes the carrying capacity, i.e., the maximum sustainable fish biomass. The model equation due to Gordon(1954) and Schaefer(1957) is The instantaneous profit rate is From (10.1) and (10.2), it follows that x will stay in the closed interval 0 x X provided x 0 is in the same interval.

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An open access fishery is one in which exploitation is completely uncontrolled. Fishing effort tends to reach an equilibrium, called bionomic equilibrium, at the level at which total revenue equals total cost. In other words, the so-called economic rent is completely dissipated. From (10.3) and (10.2), We assume. The economic basis for this result is as follows: If the fishing effort is made, then total costs exceed total revenues so that at least some fishermen will lose money, and eventually some will drop out, thus reducing the level of fishing effort. On the other hand, if fishing effort is made, then total

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revenues exceed total costs, thereby attracting additional fishermen, and increasing the fishing effort. 10.1.2 The Sole Owner Model The bionomic equilibrium solution obtained from the open access fishery model usually implies severe biological overfishing. Suppose a fishing regular agency is established to improve the operation of the fishing industry. The objective of the agency is: subject to (10.2).

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10.1.3 Solution By Green’s Theorem Solving (10.2) for u we obtain Substitute into (10.3), to obtain where where B is a sate trajectory in (x,t ) space, t [0, ).

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Let denote a simple closed curve in the (x,t ) space surrounding a region R in the space. Then, let rewrite (10.11) as As in Section 7.2.2 and 7.2.4, the turnpike level is given by

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The required second-order condition is Let be the unique solution to (10.12) satisfying the second-order condition. The corresponding value of the control which would maintain the fish stock level at is. In Exercise 10.2 you are asked to show that and also that. In Figure 10.1 optimal trajectories are shown for two different initial values:

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Figure 10.1: Optimal Policy for the Sole Owner Fishery Model

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Economic interpretation: where The interpretation of (x) is that it is the sustainable economic rent at fish stock level x.This can be seen by substituting into (10.3), where obtained using (10.12), is the fishing effort required to maintain the fish stock at level x. Suppose we have attained the equilibrium level given by (10.2), and suppose we reduce this level to by using fishing effort of.

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The immediate marginal revenue, MR, from this action is However, this causes a decrease in the sustainable economic rent which equals Over the infinite future, the present value of this stream, i.e., the marginal cost MC, is Equating MR and MC, we obtain (10.13), which is also (10.12).

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When the discount rate is zero, equation (10.13) reduces to so that it will give the equilibrium fish stock level for =0, which maximizes the instantaneous profit rate (x). This is called in economics the golden rule level. When = , we can assume that '(x) is bounded. From (10.13) we have pqx- c =0, which gives The latter is the bionomic equilibrium attained in the open access fishery solution; see (10.4).

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The sole owner solution satisfies. If we regard a government regulatory agency as the sole owner responsible for operating the fishery at level, then it can impose restrictions, such as gear regulations, catch limitations,etc., which increase the fishing cost c. If c is increased to the level, then the fishery can be turned into an open access fishery subject to those regulations, and it will attain the bionomic equilibrium at level.

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10.2 An Optimal Forest Thinning Model 10.2.1 The Forestry Model t 0 = the initial age of the forest, = the discount rate, x(t)= the volume of usable timber in the forest at time t, u(t) = the rate of thinning at time t, p = the constant price per unit volume of timber, c = the constant cost per unit volume of thinning, f(x) = the growth function, which is positive, concave, and has a unique maximum at x m ; we assume f(0)=0, g(t) = the growth coefficient which is positive, decreasing function of time.

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Form for the forest growth is where is a positive constant. f is concave in the relevant range and that. They use the growth coefficient of the form where a and b are positive constants. The forest growth equation is Objective function is The state and control constrains are (10.16) implies no replanting.

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10.2.2 Determination of Optimal Thinning Forestry problem has a natural ending at a time T for which x(T )=0. To get the singular control solution triple, we must observe that and will be functions of time. From (10.19), we have which is constant so that. From (10.18),

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Then, from (10.13), gives the singular control. Since g(t) is a decreasing function of time, it is clear from Figure 10.2 that is a decreasing function of time, and then by (10.22),. It is also clear that at time, given by which in view of f’(0)=1, gives For,the optimal control at t 0 will be the impulse cutting to bring the level from to instantaneously. To complete the infinite horizon solution, set

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Figure 10.2: Singular Usable Timber Volume

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Figure 10.3: Optimal Policy for the Forest Thinning Model when

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10.2.3 A Chain of Forests Model Similar to the chain of machines model of Section 9.3. We shall assume that successive plantings, sometimes called forest rotations, take place at equal intervals. This is similar to the assumption (9.39) employed in the machine replacement problem treated in Sethi (1973b). Let T be the rotation period, during the nth rotation, the dynamics of the forest is given by (10.13) with t [(n-1)T,nT ] and x [(n-1)T]=0.

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Figure 10.4: Optimal Policy for the Chain of Forests Model when

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Case 1: Note that in the second integral is an impulse control bringing the forest from value to 0 by a clearcutting operation; differentiate (10.25) with respect to T, equate the result to zero, If the solution T lies in, keep it; otherwise set.

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Case 2: In the Vidale-Wolfe advertising model of Chapter 7, a similar case occurs when T is small; the solution for x(T) is obtained by integrating (10.13) with u =0 and x 0 = 0. Let this solution be denoted as x*(t). Here (10.24) becomes differentiate (10.27) and equate to zero, we get If the solution lies in the interval keep it; otherwise set The optimal value T* can be obtained by computing J*(T) from both cases and selecting whichever is larger.

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Figure 10.5: Optimal Policy for the Chain of Forests Model when

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10.3 An Exhaustible Resource Model We discuss a simple model taken from Sethi(1979a). This paper analyzes optimal depletion rates by maximizing a social welfare function which involves consumers’ surplus and producers’ surplus with various weights. Here we select a model having the equally weighted criterion function.

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10.3.1 Formulation of the Model Assume that at a high enough price, say p, a substitute, preferably renewable, will become available. p(t) = the price of the resource at time t, q = f(p) is the demand function,i.e., the quantity demanded at price p; and where is the price at which the substitute completely replaces the resource. A typical graph of the demand function is shown in Figure 10.6, c = G(q) is the cost function; G(0)=0, G(q)>0 for q >0, G’>0, and G” 0 for q 0, and G’(0)<. the latter assumption makes it possible for the producers to make positive profit at a price p below,

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Q(t) = the available stock or reserve of the resource at time t, = the social discount rate, >0, T = the horizon time, which is the latest time at which the substitute will become available regardless of the price of the natural resource, T >0. Let for which it is obvious that Let denote the profit function of the producers, i.e, the producers’ surplus.

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Let be the smallest price at which is nonnegative. Assume further that is a concave function in the range as shown in Figure 10.7. In the figure the point p m indicates the price which maximizes. We also define as the consumers’ surplus, i.e., the area shown shaded in Figure 10.6. This quantity represents the total excess amount consumers would be willing to pay,i.e, consumers pay pf(p), while they would be willing to pay Note pdq= pf'(p)dp

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Figure 10.6: The Demand Function

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The instantaneous rate of consumers’ surplus and producers’ surplus is the sum. Let denote the maximum of this sum, i.e., solves In Exercise 10.14 you will be asked to show that The optimal control problem is: subject to and. Recall that the sum is concave in p.

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Figure 10.7: The Profit Function

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10.3.2 Solution by the Maximum Principle

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The right-hand side of (10.41) is strictly negative because f’<0, and G” 0 by assumption. We remark that using (10.32) and (10.39), and hence the second-order condition for of (10.32) to give the maximum of H is verified. Case 1 The constraint Q(T) 0 is not binding: (t) 0 so that

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Case 2 To obtain the solution requires finding a value of (T) such that where The time t*, if it is less than T, is the time at which which, when solved for t*, gives the second argument of (10.45).

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One method to obtain the optimal solution is to define as the longest time horizon during which the resource can be optimally used. Such a must satisfy and therefore, Subcase 2a The optimal control is Clearly in this subcase, t* = and in Figure 10.8.

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Subcase 2b Here the optimal price trajectory is where (T) is to be obtained from the transcendental equation in Figure 10.9

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Figure 10.8: Optimal Price Trajectory for

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Figure 10.9: Optimal Price Trajectory for

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