Reference no: EM132098362

Question: 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.

(b) Using a well-labelled graph, illustrate and examine Punggol Power Co.'s marginal cost function for the range Q = 0 to Q = 25000.

(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?

(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?

(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.

(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)