Question

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?

Answer 1