Dynamic Resource Allocation with Cost Externality

Abstract

The inter-temporal resource allocation efficiency of a property rights-based common-pool resource system is challenged by a cost externality when one user’s extraction raises the extraction cost for others. This paper builds a dynamic resource allocation model to illustrate the efficiency loss from a standard property rights market. We then create a novel inter-temporal allocation mechanism that preserves dynamic efficiency. Our dynamic resource allocation mechanism includes an optimal planning stage where the agents collectively determine a binding extraction target for each period and a market stage where agents can exchange their extraction rights assigned within each period. The theoretical model demonstrates that our mechanism can achieve the socially optimal allocation in two specific environments. A numerical simulation of our mechanism for a general environment consistently tracks the social optimum and significantly outperforms the traditional property rights market.