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When the government allows private firms to extract minerals offshore or on public lands, two common means of sharing in the profits are bonus bidding and production royalties. The former awards the right to extract to the highest bidder, while the second charges a per-ton royalty on each ton extracted. Bonus bids involve a single, up-front payment, while royalties are paid as long as minerals are being extracted.
a. If the two approaches are designed to yield the same amount of revenue, will they have the same effect on the allocation of the mine over time? Why or why not?
b. Would either or both be consistent with an efficient allocation? Why or why not?
c. Suppose the size of the mineral deposit and the future path of prices are unknown. How do these two approaches allocate the risk between the mining company and the government?
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