Does anyone know if it's possible to use a webcam to simulate the phone camera in the Windows Phone 7 emulator? This seems like it would be useful for creating augmented reality applications with the current tools.
It's not possible. Also at release third party developers will not have access to the camera directly. Instead you can initiate the camera tasks which will essentially start up the camera capture dialog to allow the user to grab a picture. while they are doing this your code has no control over anything. When the user takes the picture control is returned to your program along with the picture that the user took.
For the first release, augmented reality apps are out of the question -- that particular bit of hardware access just won't be available in the standard API. I wouldn't rule it out for future releases, but right now, the idea is to get the must-haves done (and done right) for the 1.0 release, with the nice-to-haves saved for subsequent releases.
Here is my trick.
Add a webcam gateway to receive HTTP request and return captured image from PC webcam and modify WP7 project slightly to simulate CameraCaptureTask behavior(but not 100% identical). Not perfect, but it makes WP7 emulator more interesting.