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Decision Making in Managerial Economics

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Ongoing U.S. struggles in Iraq and Afghanistan, political unrest in South America, and civil wars in Africa have driven crude oil prices up for the last several years. Although oil prices fell significantly in late 2008 after reaching record highs, it is widely believed that oil prices will recover and escalate again when the current worldwide economic slowdown eases. Adding to the uncertainty, it is predicted that natural gas prices, which have fallen in concert with oil and gasoline prices, will again rise dramatically 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.

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Solution Preview

It is difficult to predict the possible price variations in gas (natural gas) and oil prices. Utilities are turning towards natural gas to produce electricity for three main reasons: one, it is cheaper to set up a gas based electricity generation unit, two, it is a cleaner fuel than coal, and three, gas is usually cheaper than oil. This has attracted towards gas powered plants since their operation costs are lower and they can be used to meet demand fluctuations more efficiently.

What is needed is a way to accurately forecast gas and oil prices ...

Solution Summary

The solution gives ideas and examples about how one could make difficult decisions given the difficulty in predicting price variations in oil and gas in 402 words.

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Decision Making Managerial Economics

Please refer attached file for graphs.

With reference to the isocost curve and isoquant below, and the knowledge that labor costs $150 per unit, answer the following questions:

a. What is the price of capital?
b. What is the equation of the isocost curve?
c. What is the slope of the isocost curve?
d. If the marginal product of capital is 50 at the optimal combination of labor and capital (Point B), then what is the marginal product of labor and why? (Hint: Use mathematical conditions for optimal combination).
e.At Point A, which is greater, MPL/w or the MPK/r?
f. At Point C, the same output can be produced more cheaply by substituting _________ for __________.

2. You are the production manager of a price-taking firm. Market price is currently $25 and the chart below depicts your marginal revenue, marginal cost, average total cost and average variable cost curves.

a. Should you produce or shut down when price is $25? Why?
b. What is your profit maximizing output?
c. What is your total revenue at the optimal output?
d. What is your total fixed cost?
e. What is your total variable cost at the optimal output?
f. What is your total profit at the optimal output?
g. Demonstrate how the output associated with the maximum profit rate is not the profit maximizing output
h. Assume the market price falls to $10. Should you produce or shut down at $10? Why?
i. If you produce, how much should you produce?
j. If you produce, what is your total profit?

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