Capacity Constraints and Destructive Competition in the Extraction of Non-Renewable Natural Resources

The effects of two practical features associated with the extraction of a non-renewable natural resource on the behavior of a resource firm and industry are examined. These features are capacity and minimum efficient scale constraints. It is shown that these constraints can give rise to a phenomenon known as destructive competition. If destructive competition occurs, a perfect foresight equilibrium will not exist because the set of intertemporal shadow prices for the resource will not be sustainable by competitive behavior of firms. It is then shown that each firm's extraction path over time will be affected by these constraints and will have regions where the market price of the resource is constant. Possible time paths of momentary equilibria in a resource market are then derived when firms expectations about the resource price path are incorrect due to capacity constraints and destructive competition. Examples of destructive competition and its policy implications are also presented