The effects of capacity problem in an era of decreasing non-renewable resources

Abstract

The aim of this thesis is to establish a model where we can analyze the effect of capacity investments on the optimal choices of economic agents in an era of decreasing non-renewable energy resources. We employed a discrete time model which is a modified version of Tahvonen and Salo’s (2001) benchmark model. In our model, we have energy as an intermediate good which is used in the final good production. Since the firms in the energy market tend to behave monopolistically we also offer a second model where the energy producer is a monopolist. Our first model, depending on the initial conditions, either predicts a U-shaped time path for prices as in Tahvonen and Salo’s second model, or ever increasing prices as in benchmark model. In all cases of our second model, we found ever increasing prices for energy as our benchmark model in Tahvonen and Salo (2001). We also carry out sensitivity analysis for the parameters employed in the model. A suprising finding is that the level of energy produced icreases with the unit cost of energy in the decentralized model. This finding is a little bit controversial since we expect monopolist to produce less when it faces higher costs of production. The reason behind this unusual result is briefly as follows: energy producer’s problem is interdependent with households decisions therefore energy firm is unable to control energy prices at the steady state.