MAKING PRODUCTION DECISIONS U.S. wars in Iraq and Afghanistan, political unrest
ID: 1167395 • Letter: M
Question
MAKING PRODUCTION DECISIONS
U.S. wars in Iraq and Afghanistan, political unrest in South America, growing U.S. antipathy in Iran, and civil wars in Africa have driven crude oil prices up several times in the last several years. Although oil prices fell significantly in 2011, they are expected to rise again as the world economy recovers. Adding to the uncertainty, it is predicted that natural gas prices, which fell in concert with significant new gas field discoveries, will rise as more and more utilities switch from using coal or oil to natural gas.
Suppose you are the manager of a public utility that supplies electricity to a significant portion of your geographic region. You preside over electrical generation facilities that can produce electricity using either natural gas or oil, or some combination of both.
In the past several years, you have been faced with skyrocketing, then plummeting, natural gas prices, and now think you face the possibility of more of the same, coupled with the probability of similar volatility in oil prices.
Having been trained in Managerial Economics, you are familiar with production functions, isoquant and isocost analysis, and other tools of microeconomics. How can you use these tools to decide the best path for your company to pursue? What are the pros and cons of using these tools?
Provide specific examples of how to go about making the difficult decisions you must make in the near future as well as an overall blueprint of action.
Explanation / Answer
Fuel prices can be a real problem for companies in energy space. There are thousands of companies which still rely on production of energy from either natural gas or oil.
Natural gas in recent years is used as a alternate for oil imports. but there are significant challenges involved in production and supply of natural gas.
First of all natural gas must be piped in very high compressed state. It is not as easy as oil to ship and use and also requires considerable amount of infrastructure to even get the supply.
Oil on other hand is volatile to almost everything. It is probably the single most important good in the world. So every one want to speculate the price so to plan something with oil is much more difficult
If you use isoquant model you must remember that output must be stable no matter what the circumstances. so as a energy company if oil price is 110 usd you just cannot continue in business
The only other option is to opt for natural gas because it is usually produced domestically and prices do not speculate that much.
As energy company we must have both facilities the oil generation system along with natural gas system so when we see spike in oil prices we can shut down that unit and continue with natural gas. If oil prices drop we can just produce the energy with oil
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