Answered: FIGURE 19.7 Choosing the optimal…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

Recall the model of nonrenewable resource extraction presented in Figure. Suppose that a technological breakthrough means that extraction costs will fall in the future (but not in the present). What will this do to future profits and, therefore, to current user cost? Will current extraction increase or decrease? Compare this to a situation where future extraction costs remain unchanged but current extraction costs fall. In this situation, does current extraction increase or decrease? Does the firm’s behavior make sense in both situations? That is, does its response to the changes in production costs in each case maximize the firm’s stream of profits over time?

FIGURE 19.7 Choosing the optimal extraction level.
A firm that takes account only of current extraction
costs, EC, will produce Q, units of output in the current
period-that is, all units for which the market price P
TC - ЕС + Uс
exceeds extraction costs, EC. If it also takes account of
ЕС
user cost, UC, and the fact that current output reduces
future output and profits, it will produce only Q, units of
output-that is, only those units for which price exceeds
B
the sum of extraction costs and user cost.
UC
Q2
Qo
First-year quantity extracted
Dollars

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