The U.S. government has given Royal Dutch Shell permission to drill for oil and

Question

The U.S. government has given Royal Dutch Shell permission to drill for oil and natural gas in the Arctic Ocean. Environmentalists say it is the wrong decision.

Source: The Wall Street Journal, August 17, 2015

Explain why the oil and gas reserves are public goods, private goods, or common resources (2 point)?

When an oil company receives a permit to develop a particular oil reserve, is that oil reserve a public good or a private good? Explain (2 points).

Will the oil company produce an inefficient quantity or the efficient quantity? Explain (2 points).

To maximize utility, why does a consumer consume the combination of goods that equates marginal utility per dollar from the different goods rather than just equating the marginal utility of the different goods? (4 points)

Explanation / Answer

1) Oil and gas reserves are public good because they are the property of the nation and the license to drill them are controlled by the government. Other than this oil and gas reserves are both non-excludable and are non- rival.

2) With permit to develop a particular oil reserve the oil reserve becomes private good because now the right to produce and sell lies in the hand of oil company.

3) The company will produce inefficient because they will produce the monopoly outcomes if not regulated. And also if regulated they will produce where price = Average cost. This quantity is not efficient because at efficient level Price must equate Marginal cost.

4) Because utility is maximized where MRS = Price ratio.

MRS = MU1/MU2. Now according to the above condition MU1/MU2 = P1/P2 which is MU1/P1 =MU2/P2.

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