HOTELLING MODEL Consider a market in which today’s crude oil price is $100/bbl, and the marginal cost of extracting another barrel of oil is $50. The interest rate is 10% per year. Assume that the market iscompetitive. a. What is the best prediction for the oil price 1, 2, 3, 4 and 5 years from now, based on the Hotelling model? Calculate the oil prices at the end of years 1, 2, 3, 4, and 5. The market suddenly learns that the marginal cost of extraction in years 2 and 3 will be only $40, after which the marginal cost is expected to fall to $20
HOTELLING MODEL
Consider a market in which today’s crude oil
a. What is the best prediction for the oil price 1, 2, 3, 4 and 5 years from now, based on the Hotelling model? Calculate the oil prices at the end of years 1, 2, 3, 4, and 5. The market suddenly learns that the marginal cost of extraction in years 2 and 3 will be only $40, after which the marginal cost is expected to fall to $20 for years 4 and 5.
b. What is your prediction for future oil prices based on this new information? Calculate the oil prices at the end of years 1, 2, 3, 4, and 5. [Hint: assume that the price of year 1
stays as in part a.]
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