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Chapter 12: Problem 8

A columnist for the Wall Street Journal discussed the fact that some firms were buying existing drilling operations in Canadian oil sands regions. These operations would not have been profitable to build from scratch but were profitable to operate given that they were already built because, as the columnist said, "The key is the distinction between fixed and variable costs. While the fixed investment in new oil sands projects is prohibitive, variable costs can be in the low \(\$ 20\) range per barrel." The columnist estimated that the fixed cost of a new oil sands drilling operation could be \(\$ 95\) per barrel. At the time the column was written, the price of oil was about \(\$ 50\) per barrel. a. Assuming that variable cost of an existing oil sands operation is \(\$ 20\) per barrel and the price of oil is \(\$ 50\) per barrel, how much were the companies selling these drilling operations losing per barrel? b. At a price of \(\$ 50\) per barrel, were the companies buying the existing drilling operations earning a profit of \(\$ 30\) per barrel? If not, explain what information we would need to calculate their profit.

Short Answer

Expert verified
(a) The companies selling the drilling operations are not losing but are making a profit of $30 per barrel. (b) The companies buying the operations are also making an earning of $30 per barrel, but without knowledge of their fixed costs, one cannot confirm if this is a profit or loss.

Step by step solution

01

Determine Variable and Fixed Costs per Barrel - Part a

For the companies selling the drilling operations, the variable cost per barrel is given as $20. The fixed cost per barrel would not be relevant to these companies as they are already sunk costs.
02

Calculation of Loss per Barrel - Part a

Given that the selling price per barrel is $50 and the variable cost per barrel is $20, subtract the variable cost from the price to calculate the amount the selling companies are earning or losing per barrel. The calculation is $50 - $20 = $30. The selling companies are not losing but rather making a $30 per barrel.
03

Determine Costs and Revenue per Barrel - Part b

For the companies buying the existing operations, the variable cost per barrel is $20. Without additional information, we're not sure about the fixed costs per barrel these companies have to pay. The revenue per barrel they receive is $50.
04

Calculation of Profit per Barrel - Part b

Without the fixed cost, the calculation for determining profit per barrel would be the same as for loss. Here, a $30 earning per barrel ($50 - $20) can be calculated. However, this does not consider any fixed costs per barrel. For actual profit, we would need to subtract any fixed costs from this $30.

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Most popular questions from this chapter

Hedrick Smith was a foreign correspondent for the New York Times who lived in the Soviet Union in the \(1970 \mathrm{~s}\), a period when the country had a planned economy rather than a market system. In a book he wrote about everyday life in the Soviet Union, Smith made the following observations about shopping in Moscow: At first it seemed \(\ldots\) that the stores were pretty well stocked. Only as we began to shop in earnest \(\ldots\) did the Russian consumer's predicament really come through to me. First, we needed textbooks for our children \(\ldots\) and found that the sixth-grade textbooks had run out.... We tried to find ballet shoes for our 11 -year-old daughter... only to discover that in this land of ballerinas, ballet shoes size 8 were unavailable in Moscow.... I tried to find shoes for myself. They were out of anything in my size but sandals or flimsy, lightweight shoes that the clerk, with one look at me, recommended against buying. "They won't last," he admitted. a. Judging by Smith's observations, briefly explain whether the Soviet Union achieved allocative efficiency in the production of sixth-grade textbooks, ballet shoes, and men's shoes. b. Can we tell from these observations whether the Soviet Union achieved productive efficiency in the production of sixth-grade textbooks, ballet shoes, and men's shoes? Briefly explain.

Suppose that currently the market for gluten-free spaghetti is in long-run equilibrium at a price of \(\$ 3.50\) per box and a quantity of 4 million boxes sold per year. If the demand for gluten-free spaghetti permanently increases, which of the following combinations of equilibrium price and equilibrium quantity would you expect to see in the long run? Carefully explain why you chose the answer you did. a. A price of \(\$ 3.50\) per box and a quantity of 4 million boxes b. A price of \(\$ 3.50\) per box and a quantity of more than 4 million boxes c. A price of more than \(\$ 3.50\) per box and a quantity of more than 4 million boxes d. A price of less than \(\$ 3.50\) per box and a quantity of less than 4 million boxes

Briefly explain whether a firm earning zero economic profit will continue to produce in the long run.

Why are consumers so powerful in a market system?

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