Price and Extraction Path over Time

It is obvious that the industry would reduce quantity extracted over time in order to obtain higher prices, i.e., net price must go up over time. The price can go up until a point at which no one is willing to buy the product. This is the 'choke price', i.e., the price at which the demand for commodity is zero. At this point, either the substitute product or the substitute technology will start operating at a lower cost.

This is called 'backstop technology'. Hence, if there is any stock left on the ground when the price hits the choke price, then it is a waste for the owner because the leftover can never be sold at that price. Therefore, the resource owners will want to deplete their resources completely when the choke price is reached. This extraction path will indicate the time path of price.

Figure :  Price Path

In the below diagram, the optimal price and extraction paths have been compared with non-optimal paths represented by slower and faster extraction rates as compared to the optimal rate. In below diagrams inefficient extraction and price paths are compared with the efficient path A. Path B illustrates extraction that is too fast relative to the efficient path. More is extracted in each time period under path B. Mineral reserves are depleted before the choke price is reached if path B is followed. Path C illustrates extraction that is too slow relative to the efficient path. The choke price is reached before the mineral reserves are depleted. Therefore, paths B and C are inefficient.

Figure :  Extraction Path