Learning and Price Volatility in Duopoly Models of Resource.pdf

Learning and Price Volatility in Duopoly Models of Resource Depletion∗ Martin Ellison Andrew Scott University of Oxford and CEPR London Business School and CEPR March 21, 2008 Abstract The aim of this paper is to provide a theoretical model that can account for price fluctuations in depletable resource markets. We do so by introducing learning into a Hotelling-style duopoly model of optimal resource depletion. Before the depletable re- source becomes scarce, the self-confirming equilibrium of the model mirrors noncooper- ative rational expectations equilibrium in that supply is high and price is low, although learning does induce occasional upward price spikes that are followed by a long period of falling price. Once the depletable resource becomes scarce the dynamics of the mar- ket change significantly, with the self-confirming equilibrium mirroring the cooperative rather than noncooperative rational expectations equilibrium. Supply is low and price is high. Price spikes still occur but against a background of increasing prices. When scarcity is sufficient then the market is permanently in a self-confirming equilibrium that is equivalent to cooperative rational expectations equilibrium. ∗We thank participants at the European Summer Symposium in Macroeconomics (Izmir 2007) for helpful comments and suggestions. 1 1 Introduction Depletable or nonrenewable resources are by definition1 characterised by a finite stock and so likely to be in the hands of a small number of suppliers. Many real world examples of de