Question

In recent years, the United States has experienced large increases in oil production due in large part to a new technology, hydraulic fracturing (“fracking”). Fracking involves injecting a mixture of water, sand, and chemicals into rock formations at high pressure to release oil and natural gas. An article in the Wall Street Journal indicates that economies of scale in fracking may be considerably smaller than in conventional oil drilling. If this view is cor- rect, what would the likely consequences be for the num- ber of firms drilling for oil in the United States?

Answer 1

Economies of Scale can be defined as the advantages in cost which a firm gains with an increase in the level of the production. In other words, when a firm increases its output, the cost advantages increase which is called the economies of scale. This happens with the organizations who are efficient in production and have large sizes so that the per unit cost of output produced decreases with increased production.

In this case, economies of scale in fracking is considerably smaller than in drilling. This means that the cost advantages in increased production of oil with the method of fracking is considerably less as compared to the method of drilling.

If this view is correct, then the number of firms using the drilling method will experience an expansion in their production scale. In the long run, the oil firms in the US will experience an increase in efficiency in obtaining the oil through drilling, and they will expand. However, expansion of the firms after a certain level will lead the firms to experience 'diseconomies of scale.' Diseconomies of scale are the costs incurred by the firms due to factors which are not in its own hands as a result of increased expansion.

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