Scenes from a Monopoly: Renewable Resources and Quickest Detection of Regime Shifts Neha Deopa * and Daniele Rinaldo † The Graduate Institute of International and Development Studies, Geneva, Switzerland. Abstract: We study the stochastic dynamics of a renewable resource harvested by a mo- nopolist facing a downward sloping demand curve. We introduce a framework where harvesting sequentially affects the resource’s potential to regenerate, resulting in an endogenous ecological regime shift. In a multi-period setting, the firm’s objective is to find the profit-maximizing har- vesting policy while simultaneously detecting in the quickest time possible the change in regime. Solving analytically, we show that a negative regime shift induces an aggressive extraction be- haviour due to shorter detection periods, creating a sense of urgency, and higher markup in prices. Precautionary behaviour can result due to decreasing resource rent. We study the prob- ability of extinction and show the emergence of catastrophe risk which can be both reversible and irreversible. 1 Introduction The exploitation of renewable resources, such as overfishing of the North Sea cod, deforesta- tion in the Amazon and soil degradation due to unsustainable agricultural practices, is an issue that is receiving considerable attention. The dynamic management of such resources often in- volves decisions concerning optimal extraction policies under ecological uncertainty, defined by Pindyck (2002) as uncertainty over the evolution of the relevant ecosystem. This raises pertinent economic questions about the behaviour of a firm harvesting these resources, especially if the dynamics driving the resource growth change. One way that the current literature captures this source of uncertainty is by means of stochastic bio-economic models, reflected in the variance of the fluctuations. Another way is to focus on ecological regime shifts, defined as an abrupt change in the structure of the natural ecosystems supplying the resource or a change in the system dynamics such as intrinsic growth rate or the carrying capacity of the resource (Polasky et al. (2011); Arvaniti et al. (2019)). There already exists a large literature studying the impact of stochastic fluctuations on ex- traction activities, mainly utilizing real options theory (Andersen and Sutinen (1984); Pindyck (1984); Reed (1988); Reed and Clarke (1990); Saphores (2003); Alvarez and Koskela (2007); Pizarro and Schwartz (2018)). An emerging literature builds on this to integrate resource man- agement with a variety of regime shifts, such as Polasky et al. (2011), Ren and Polasky (2014), Baggio and Fackler (2016), de Zeeuw and He (2017) and Arvaniti et al. (2019) 1 . These stud- ies, however, are limited in two respects. With the exception of Pindyck (1984), none of these works incorporate a market structure and take the price as fixed or exogenous. This is done for tractability reasons but leads to results that may underestimate the crucial role of a market structure, which often indeed drives firms’ harvesting decisions. Furthermore, the literature on regime shifts implicitly assumes the firm to be able to discern the change in resource dynamics and subsequently make the appropriate extraction decision 2 . In this paper we take a different * neha.deopa@graduateinstitute.ch † daniele.rinaldo@graduateinstitute.ch 1 Refer to Li et al. (2018) for an overview. 2 We use the words extraction and harvesting interchangeably. 1 arXiv:2005.11500v2 [q-fin.EC] 1 Jun 2020