Managerial Economics

Punggol Power Co. (PPC) operates two power plants: a 15,000 kWh fuel oil plant, and a

5,000 kWh natural gas plant. The kWh figures refer to the plant’s maximum generating

capacity. At current fuel prices, it costs $0.15 to generate 1 kWh from the fuel oil plant, and

$0.20 to generate 1 kWh from the natural gas plant. PPC can buy any amount of fuel and

generate any amount of power (up to the operating capacity of each power plant). PPC also

faces costs which do not vary with output: these are depreciation of $1,500 for the fuel oil

plant, $1,000 for the natural gas plant, and $2,000 for management costs. It is not possible to

sell any plants or change management. If Punggol Power Co. needs to supply electricity

above their maximum operating capacity, PPC has a contract with another power generator to

purchase as much power as needed (for resale) for $0.30 per kWh.

(a) Write down Punggol Power Co.’s fixed cost, marginal cost, and total cost function.

Briefly explain your answer for each cost component. Hint: You should think about

the order in which power plant(s) should be used, to minimise the costs of supplying a

given quantity of power; your final answer may have multiple total cost functions.

(6 Marks)

(b) Using a well-labelled graph, illustrate and examine Punggol Power Co.’s marginal

cost function for the range Q = 0 to Q = 25000.

(4 Marks)

(c) Market demand for electricity is given by P = 2 – 0.0001Q. If Punggol Power Co. set

prices as though it were a perfectly competitive firm, what would be the market price

and quantity?

(5 Marks)

ECO201e Group-based Assignment


(d) Suppose Punggol Power Co. set prices as though it were a monopoly. Market demand

remains the same at P = 2 – 0.0001Q. What would be the market price and quantity?

(5 Marks)

(e) A new energy market policy prevents Punggol Power Co. from selling to customers

directly. Instead, Punggol Power Co. must tender for a contract to supply a fixed

amount of electricity. The contract is for 22,000 kWh. In the short run, considering

the shutdown condition, compute the minimum price that Punggol Power Co. can

afford to bid in their tender. Explain your reasoning.

(5 Marks)

(f) Punggol Power Co. is considering restructuring their assets to become more

competitive in the long run when tendering to supply electricity. PPC is considering

selling the natural gas plant. The sale price is expected to equal existing debt for the

plant and will not generate profits. Should PPC sell their plant, and how does their

decision depend on forecasts of future electricity demand? Remember that PPC has a

contract to purchase as much power as needed – for resale – for $0.30 per kWh. (Hint:

PPC’s objective should be to minimise their long-run breakeven price)

(10 Marks)

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