An overlapping generations model with exhaustible resources and stock pollution

Abstract

This paper analyzes the nexus between resource exhaustion and pollution externality using an overlapping generations framework where each generation lives only for a finite period. For a finite horizon model with production where there are many agents per generation, the Pareto inefficiency arises due to lack of intragenerational coordination and is propagated across generations. The tax rates necessary for correcting this externality are characterized. We also derive a modified Hotelling rule according to which the equilibrium resource price rises slower than the rate of interest in order to account for the damages due to the pollution stock generated by the resource used. For the case where the externality induced damage acts on production rather than the utility function, Pareto inefficiency is shown to persist even when there is intragenerational coordination.