Question
Scenarios A and B are identical in every respect (e.g. demand function, initial resource stock, and extraction cost function), except for the following: in Scenario
Scenarios A and B are identical in every respect (e.g. demand function, initial resource stock, and extraction cost function), except for the following: in Scenario A, a backstop with constant marginal cost b is available at time t = 0; in Scenario B it is known at time t = 0 that the backstop will not become available until t = 49. (a) Suppose that in Scenario A, the backstop begins to be used at time t = 50. What, if any, is the dierence in extraction trajectories in the two scenarios? Explain your answer brie y. (b) In Scenario C everyone knows that the backstop will be available at t = 51. Draw a gure showing (only) the two equilibrium price trajectories in scenarios B and C (corresponding to the two known arrival times of the backstop, t = 49 and t = 51. Brie y explain why the two trajectories are slightly dierent. (c) Now consider a case with uncertainty. At t = 0 everyone knows that the backstop will become available either at t = 49 or at t = 51. Each of these outcomes is equally likely. (The uncertainty is esolved" at t = 49: either the backstop becomes available, and everyone knows this, or it does not become available; in the latter case, everyone knows that it will become available to t = 51. In either case, there is no more uncertainty after t = 49.) Reproduce your gure from part (b) and draw the equilibrium price trajectory prior to t = 49 for the scenario with uncertainty. Your goal is to gure out the relation between this trajectory and two trajectories under certainty with dierent times of availability.
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