ON OPTIMAL CAPACITY EXPANSION FOR DOMESTIC PROCESSING OF AN EXHAUSTIBLE, NATURAL-RESOURCE

The issue of optimal capacity expansion for domestic processing of exh austible, natural resource exports in a small open economy is analyzed in the context of non-malleable capital. A complete qualitative chara cterization of the optimal dynamic paths for resource extraction, dome stic processing, and capacity expansion is obtained. It is shown that the presence of capital-stock adjustment costs, which vary directly wi th the rate of capacity expansion in the resource-processing sector, i mplies a presumption in favor of a policy of domestic processing, and that the optimal pattern of capacity expansion is of the front-end loa ding variety. (C) 1997 Academic Press.