Question:
Ongoing U.S. struggles in Iraq, political unrest in South America, and civil wars in Africa are again driving crude oil prices up. If the spreading unrest continues, it is widely believed that oil prices will continue to escalate. Adding to the uncertainty, it is predicted that natural gas prices in the United States will again rise dramatically this winter heating season.
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 3 years, you have been faced with skyrocketing natural gas prices, and now think you face the possibility of more of the same, coupled with similar increases in oil prices. How can you use production functions, isoquant and isocost analysis, and other tools of microeconomics to decide the best path for your company to pursue? What are the pros and cons of using these tools?