Question 1: Hotelling’s Rule in a rapidly changing market Let’s assume that oil was not discovered until the year 1999. The New York Times writes that “a source of energy with potential disruptive effects on the world economy” is now ready for production, and “other countries are watching the developments closely”. Along with many other producers, you own a small oil well. The market is very competitive. The marginal extraction cost is $10 per barrel. The interest rate is 5%. The annual demand for oil is Q = 90,000 – 2,000P where Q is in barrels per year and P is in dollars per barrel. Use your knowledge about Hotelling’s Rule to answer the following questions: a. Oil is trading for $25/bbl on Jan 1st, 1999. What do you expect the path of oil prices and extraction quantities to be from 1999-2010 (assuming no shocks to the market)? A day later, on Jan 2nd, 1999, the Wall Street Journal opens with a story that there is now a more reliable reserves estimate. Total reserves are estimated at 760,000 barrels.
Question 1: Hotelling’s Rule in a rapidly changing market
Let’s assume that oil was not discovered until the year 1999. The New York Times writes that
“a source of energy with potential disruptive effects on the world economy” is now ready for
production, and “other countries are watching the developments closely”.
Along with many other producers, you own a small oil well. The market is very competitive. The
marginal extraction cost is $10 per barrel. The interest rate is 5%. The annual demand for oil is
Q = 90,000 – 2,000P where Q is in barrels per year and P is in dollars per barrel.
Use your knowledge about Hotelling’s Rule to answer the following questions:
a. Oil is trading for $25/bbl on Jan 1st, 1999. What do you expect the path of oil prices
and extraction quantities to be from 1999-2010 (assuming no shocks to the market)?
A day later, on Jan 2nd, 1999, the Wall Street Journal opens with a story that there is now a
more reliable reserves estimate.
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