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Midterm Exam Econ 435
The Economics of Energy
Olivia Sherwani
ECON 435
3/30/20
Word count: Approximately: 1112
Number 2
a) I do not have enough information to recommend investing in the project. The
price of barrel is not given so that we can calculate the revenue.
b) Year = 100,000 x 50 = 5,000,000 per year; for 10 years = 10 x 5,000,000 =
50,000,000
c) Revenue - cost = 5,000,000 - 100,000 = 4,900,000
d) The hurdle rate (discount rate) is not given. This will impact my conclusions but
without knowing what the discount rate was, we cannot determine the net
present value.
e) Break-even hurdle rate is called Internal Rate of Return (IRR), I used an IRR
calculator and put my initial investment as 10,000,000 & the net annual revenue
from c) which is 4,900,000 and got 51% for the IRR.
Number 3
a) Being dependent on imported oil could negatively impact national security. The
other countries that are exporting oil could take advantage of the dependent
countries by raising oil prices. Assuming the price increases, it could cause
inflation.
b) Energy independence on imported oil is when a nation does not need to import
and is able to produce the sufficient amount needed. Although energy
independence sounds good, it is not realistic. The US already produces oil and
still continues to trade with other countries because this helps the US and other
countries get what is needed. This is like the food chain, you do not want to stop
the supply chain.
c) I believe in the “running out of oil” is a significant matter of economics. Oil is a
critical part of life, it is a necessity that we can’t imagine living without. Oil is a
vital part of our lives since we use it for transportation, heating, cooking etc, just
to name a few. The failure to find major new fields in the last thirty years shows
that we may be exhausting our resources and shows that we will run out in the
future
Midterm Exam Econ 435
The Economics of Energy
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d) Prices of oil were stable prior to 1973, prices drastically increased in 1973 due to
Yom Kippur war, and in 1979 due to the Iranian war. Increases in oil prices
increase inflation and decrease economic growth.
e) Overtime gasoline has become more elastic because there more alternatives
available. The implications of this will be if prices increase then the demand will
go down.
Number 4
a) The rule of capture states that the first person to capture a natural resource,
(such as groundwater, oil, gas, and game animals), owns that resource. The rule
was adopted based on the case of Pierson v. Post which involved a wild fox.
After the Pierson v. Post case the rule of capture was adopted in all states that
produced oil and gas.
b) The rule of capture makes sense for trapping a fox. A fox is a wild animal and not
a pet therefore if the fox is on someone else’s property or in an area where
hunting is allowed then whoever captures the fox, can claim ownership of it. If the
fox belongs to someone like a normal pet then it should not be out in the open to
be captured or hunted.
c) Economic arguments against the rule of capture is that it impacts someone else
negatively. In the fox story the person that thinks the fox belongs to them, has no
control of who shoots or takes the fox even though they think its theirs. In an oil
situation where there is oil under two or more properties, the person that does
not agree to drill will be impacted negatively by the noise, pollution and all of their
oil under their property will be taken also if their neighbors drill.
d) The rule of capture can be a serious problem if an oil field is shared by many
property owners, because if one of the owners wants to drill and the others don’t
want to drill then the one drilling could cause many externalities such as
pollution, noise and danger to the other area. Also, if one of them decides to drill,
they will be drill underground and taking the oil from the other properties.
e) The regulatory solution to mitigate the harm is to have an oil company come in
and professionally drill. They can drill the oil in an optimal safe process. The
property owners can either all agree to drill and get a percentage or they can all
agree to not drill. If they agree, it would benefit them monetary wise as well as
being able to drill correctly.
f) The problems that could arise could come up if a property owner doesn’t want
drilling done on their property and assumes that the oil under their property is not
being touched. There is also not a way to assess how much oil they can get out
of the land. If they drill on one property, the drilling may not be optimal and they
may not get as much as they could if they drilled in a better area.MonM
Midterm Exam Econ 435
The Economics of Energy
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Number 6
a) Natural monopoly is where one company can provide a good or service at a
lower cost than two or more companies. The mathematical conditions necessary
for a firm to operate in a market can be written as Company1 < Company2 +
Company3 + etc (it may or may not be more than two companies).
b) Government regulations are one way of addressing the natural monopolies so that the
company does not take advantage of consumers. Sometimes the firms are divided into
smaller companies, another way is to leave the natural monopoly alone which will
determine MR=MC. Usually utility companies are regulated because it wouldn’t make
any sense to divide those companies since it would be too costly.
c) The oil industry is not a natural monopoly because it is not one firm supplying the
total quantity demanded.
d) Antitrust regulations will break up monopolies and regulate them. Government
regulations prevent price gauging, if the government doesn’t regulate monopolies
then companies would set prices above equilibrium price.
e) It would be very complicated to de-regulate the public utility market. Things to
consider is how these are set up and how each public utility goes to each and
every house. For example, an electric company or gas company, has electricity
wires, gas lines respectively going to each home if another company wanted to
get into the market they would have to create lines to the houses so it would be
complicated and expensive for another company to offer the services to
consumers. If the government does not regulate the current public utility
company’s then they would inflate prices. The regulations are in place to protect
consumers.
Midterm Exam Econ 435
The Economics of Energy
References
Bosselman, Fred, Eisen, B., Joel, Rossi, Jim, Spence, B., David, Weaver, Jacqueline
(2010). Energy, Economics and the Environment Cases and Materials (3rd
ed.).Thomas Reuters/Foundation Press.
Rule of Capture. (2019, June 10). In Wikipedia. Retrieved from
https://en.wikipedia.org/wiki/Rule_of_capture
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