Exploration in a two period model

Suppose that a supply of natural gas is to be allocated across two identical periods with the following characteristics:

• Demand: W2Pi = 740 – Qi
• Marginal extraction cost: $140
• Known quantity available: 390 units
• Interest rate: 100%
  

In addition, it is possible to find additional units of gas via exploration. The cost of drilling a well is $160. Eighty percent (80%) of the time, no gas will be found and 20% of the time 2 units will be found (note the 2).  Any units found would be subject to the MEC noted above.

1. Please calculate the market equilibrium taking exploration into account. Summarize your results in a table giving the values of the following variables in each of the two periods: royalty, price and quantity. Also, please calculate the number of units that will be found via exploration.

 

When you're done, you can check your work via the link below: