Lights Out. Businesses Out?
Subject Types of costs and shut down condition
Topic Production and Costs
Key Words Energy costs, shut down, prices, production, consumers, profits
News Story

In California, energy costs are spiraling. Natural gas prices rose first; now electricity prices have been permitted to increase. Businesses are hurting. For instance, a potato flake plant in Tulelake is shutting down for the second time in a month because of a sixteen-fold increase in natural gas bills. Flower growers are threatened because their greenhouses use energy-gobbling lamps. Farmers who use fertilizer (a key ingredient of which is natural gas) are expecting to have to increase prices. Rolling blackouts cause restaurants to limit their menus to items that can be cooked without high heat, stores to close, and firms to lose production. Consumers, faced with higher energy bills, have less money to spend on goods and services, exacerbating the plight of California's economy.

In general, profits are endangered, prices could increase, and production may be curtailed. Some producers are thinking about leaving the state. However, the effects are being felt elsewhere in the country. For example, the potato flake plant sells to other producers such as Procter and Gamble to make potato chips and instant mashed potatoes.

(Updated February 1, 2001)

1. Are energy costs fixed or variable costs? Why?
2. Draw a price/cost-output diagram of the potato flake manufacturer. Include the average total, average variable, and marginal cost curves. Draw a price line such that the producer is breaking even. Mark the equilibrium price and output levels.
a) Show the effect of the higher energy costs. Why did you move the curves you did? What happened to the equilibrium price, output and profit?
b) On occasions, the potato flake manufacturer had to shut down temporarily. At what level must average variable costs been? Explain your answer.
3. a) The news story indicates that prices may increase as a result of the increase in energy costs. However, it also states that consumers are likely to be cutting back on their spending. What will happen to prices overall? Explain your answer.
b) Look at your diagram and judge what would happen to the equilibrium output level and the amount of profit or loss as a result of your answer in (a).
Source Matt Krantz and Jon Swartz, "California's power costs zap businesses," USA Today, January 17, 2001.

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