Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 15: Q8. (page 606)

Suppose your uncle gave you an oil well like the one described in Section 15.8. (Marginal production cost is constant at \(50.) The price of oil is currently \)80 but is controlled by a cartel that accounts for a large fraction of total production. Should you produce and sell all your oil now or wait to produce? Explain your answer.

Short Answer

Expert verified

The cartel should sell the oil today and invest the gain to maximize the present value.

Step by step solution

01

Step 1. Explanation

A cartel is a group of producers or firms who join hands to maximize profit by controlling the price. The cartel maximizes the profit where the marginal cost is equal to marginal revenue. The prevailing price minus the marginal cost will rise less than the interest rate as the cartel accounts for a large fraction of production.

The cartel operates at the output level where the marginal revenue less marginal cost should increase at the interest rate, but the price minus marginal cost will grow less than the interest rate. Hence, to maximize the present value of the gain from selling the oil, the oil should be sold today, and profits to be invested at the prevailing interest rate.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

Suppose the interest rate is 10 percent. What is the value of a coupon bond that pays \(80 per year for each of the next five years and then makes a principal repayment of \)1000 in the sixth year? Repeat for an interest rate of 15 percent.

Suppose you can buy a new Toyota Corolla for \(20,000 and sell it for \)12,000 after six years. Alternatively, you can lease the car for \(300 per month for three years and return it at the end of the three years. For simplification, assume that lease payments are made yearly instead of monthly—i.e., that they are \)3600 per year for each of three years.

  1. If the interest rate, r, is 4 percent, is it better to lease or buy the car?
  2. Which is better if the interest rate is 12 percent?
  3. At what interest rate would you be indifferent between buying and leasing the car?

Suppose the interest rate is 10 percent. If \(100 is invested at this rate today, how much will it be worth after one year? After two years? After five years? What is the value today of \)100 paid one year from now? Paid two years from now? Paid five years from now?

The market interest rate is 5 percent and is expected to stay at that level. Consumers can borrow and lend all they want at this rate. Explain your choice in each of the following situations:

  1. Would you prefer a \(500 gift today or a \)540 gift next year?
  2. Would you prefer a \(100 gift now or a \)500 loan without interest for four years?
  3. Would you prefer a \(350 rebate on an \)8000 car or one year of financing for the full price of the car at 0-percent interest?
  4. You have just won a million-dollar lottery and will receive \(50,000 a year for the next 20 years. How much is this worth to you today?
  5. You win the “honest million” jackpot. You can have \)1 million today or \(60,000 per year for eternity (a right that can be passed on to your heirs). Which doyou prefer?
  6. In the past, adult children had to pay taxes on gifts of over \)10,000 from their parents, but parents could make interest-free loans to their children. Why did some people call this policy unfair? To whom were the rules unfair?

A consumer faces the following decision: She can buy a computer for \(1000 and \)10 per month for Internet access for three years, or she can receive a \(400 rebate on the computer (so that its cost is \)600) but agree to pay \(25 per month for three years for Internet access. For simplification, assume that the consumer pays the access fees yearly (i.e., \)10 per month = $120 per year).

a. What should the consumer do if the interest rate is 3 percent?

b. What if the interest rate is 17 percent?

c. At what interest rate will the consumer be indifferent between the two options?
See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free