Resource Economics’s Most Problematic Assumption

Every theory or, to use the term famously coined by Thomas Kuhn, paradigm is based on a set of assumptions. Some assumptions are more, others less important for the overall theoretical system that is built upon them. This has to do with the ease with which they can (or cannot) be relaxed if shown not valid. It is, however, a truism that every model, theory or paradigm must be based on simplifying assumptions and that “closeness to reality” is seldom a relevant criterion for their evaluation (this latter statement must be, of course, qualified, which I will do below). Resource economics, i.e., the branch of economic theory that deals with the exploration, extraction and markets for (non-renewable) resources is no exception from this rule. One of my professors at the university used to present empirical findings regarding important assumptions of economic theory (such as the interest rate parity) by stating: “This is one of the few economic assumptions that stand up to reality.” The so-called Hotelling’s rule, one of the crucial models and assumptions of resource economics, is not one of those few. Continue reading