Exploration and Exhaustible Resources: The Microfoundations of Aggregate Models.

The appropriate specifications for aggregate extraction and exploration cost functions are derived from a disaggregate model of the search for low-cost deposits of an exhaustible resource. The common practice of combining the no-discovery extraction cost function with exploration is shown to result in a misspecified model for which the total cost of extracting the resource is not well defined. The widely accepted prediction that the anticipated discovery of low-cost deposits results in a U-shaped price path appears to be an artifact of this misspecification. For the authors' properly specified cost functions, the predicted resource price always rises. Copyright 1989 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.