Question

A company is looking to build a new headquarters in Texas. After they purchase the land and have begun building, they realize there is oil on the property. The marginal benefit and marginal cost of extracting that oil is:

MB = 480 - 4Q

MC = 6Q

A. (5 points) The company is consider a two-year planning horizon and seeks to maximize profits from the oil. How much oil will the company extract in the first year if they fail to consider the marginal user cost (MUC)?

B. (6 points) Now, the company discovers that there are 50 barrels of oil on the property, but they decide that they should still take the MUC into account when deciding how much to extract this year and the next year.  If they use a 10% discount rate, how much should they extract each year?

Answer 1

(A) In this case, company will equate MB = MC that is the profit maximizing condition if MUC is not taken in to account.

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48 Barrels of oil will be extracted this year.

(B) Now company will maximize two period payoff while keeping in mind the limit of 50 Barrels of oil.