Hotelling's rule

Harold Hotelling published a paper The Economics of Exhaustible Resources in the Journal of Political Economy in 1931, this analysis lead to what became known as Hotelling's rule.

Hotelling was an American mathematical statistician and an economic theorist who is also associated with other phrases including Hotelling's law, Hotelling's lemma and Hotelling's T-square distribution in statistics. Hotelling's rule, although established in the 1930s became well know in the 1970s after the oil crisis and high oil prices because it looked at how the economics of finite resources, such as oil from an economic perspective. It is also relevant today in relation to the construction of buildings because there is increasing awareness of the environmental impacts of material use in buildings and the differentiation between renewable and non-renewable resources.

Standard capitalist economics, usually looks at how prices are established on normal goods or services, in the neoclassical sense or a demand and competition context, the aims being to achieve maximum profits for producers with minimimal costs. In this scenario the economic rules generally show that price equals marginal cost in perfect competition. Hotelling introduced into this equation the possibility resources are not infinately available, and many are indeed finite with limited availabilty, such as coal, oil, natural gas (something people became increasingly aware of from the 1970s).

The rule shows that, in the profit-maximization scenario, if a resource is finite, the producer will not just charge a marginal cost, he will need to also charge a premium which he called the scarcity rent. This scarcity rent premium allows for the fact that once consumed, that one unit of finite resource, is no longer available in the future. So once this is factored into the equation the logical economics would be to sell the product or resource a price that increases at the rate of interest.

Or in other words 'the net price path is a function of time, while maximizing economic rent during the time of fully extracting a non-renewable natural resource. The maximum rent, the scarcity or Hotelling rent is the maximum rent that could be obtained while emptying the stock resource. In efficient exploitation of a non-renewable and non-augmentable resource, the percentage change in net-price per unit of time should equal the discount rate in order to maximise the present value of the resource capital over the extraction period.'

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