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Continuing with the story of Wyoff Resources from the previous question. The cost of extraction depends on the amount remaining in the reservoir.
Continuing with the story of Wyoff Resources from the previous question...
The cost of extraction depends on the amount remaining in the reservoir. The cost of extracting Y t units of oil in period 't' is C(Yt | St)=Yt2/St2 where S t is the amount in the reservoir at the beginning of period 't'.
The government of NWT will face an election no later than the end of 2017. The opposition party, which is gaining support, has promised to impose a tax on Wyoff's oil revenues.
Consider a radically different set of beliefs acted upon by Wyoff's managers. In this case, the executives have reason to believe that the opposition party WILL be elected and that it WILL implement a tax on Wyoff's revenue of 0.25 per unit of oil extracted and sold.
The tax is to be imposed as of January, 2018. This change in tax is perfectly foreseen by Wyoff's managers as of January, 2015.
The entire five-year extraction program (years 2015, 2016, 2017, 2018, and 2019) is planned on the assumption that the net-of-severance-tax price will be $1 in each of 2015, 2016 and 2017 (no tax imposed) and the net price received by Wyoff will be $0.75 in each of 2018 and 2019.
How much oil will Wyoff choose to abandon after the imposition of the tax? (How much oil will be abandoned in this world of a perfectly-foreseen price decrease for years 2018 and 2019?)
1. Will abandon at least 14% of the reservoir but less than 15%
2. Will abandon at least 16% of the reservoir
3. Will abandon less than 12.5% (one-eighth) of the original amount in the reservoir
4. Will abandon at least 15% of the reservoir but less than 16%
5. Will abandon at least 12.5% of the reservoir but less than 14%
