Question

S residents and domestic companies consume 6 billion megawatts of electricity each year. Aside from a few large companies that generate their own electricity, everybody else buys electricity from electric utility companies. These utilities have a variety of sources for the electricity that they generate -- coal, oil, natural gas, nuclear, and hydro plants. Which of these sources have the high fixed costs and which have low fixed costs? Why? What about variable costs? How do you think managers of electric utilities decide which energy source they should choose to power the large spinning turbines that create electricity?

Answer 1

Low fixed costs - coal, oil, natural gas
high fixed costs - nuclear, hydro

The cost of setting up a plant differ for the above types of sources with low fixed costs sources being easier to set up. However, hydro and nuclear required bigger investments in plant (location for hydro and safety for nuclear) and machinery (technological costs)

There is a trade off between fixed and variable costs, therefore:
Low variable costs - coal, oil, natural gas
high variable costs - nuclear, hydro

Managers of electric utility will consider Levelized Cost of Energy (LCOE) which is equal to the average price per unit of output needed for the plant to break even over its operating lifetime. If the LCOE criteria is met as per the demand, then the managers will look to maximize the profitability (i.e. Revenue-Total cost). As the demand increases, the unit fixed costs will decline and therefore, nuclear and hydro will become more profitable.