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Lecture 26

# ECON366 Lecture 26: EMC Calculation

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School
Department
Economics
Course
ECON366
Professor
Dana Andersen
Semester
Fall

Description
ECON 366 Lecture 26 EMC calculation Expected value calculation EMC P= in situ price, Q=quantity, C=extraction cost, =other discounting factor, = probability of success, u1= probability of Q1, u2 = probability of Q2, v1=probability of P1, v2=probability of P2 Case 1: no uncertainty EMV = C + PQ If EMC>0, then the firm should drill Case 2: success uncertainty EMV = C + PQ If EMC>0, then the firm should drill Case 3: quantity uncertainty (2 quantities) EMC = C + (u PQ + u PQ ) 1 1 2 2 If EMC>0, then the firm should drill Case 4: price uncertainty (2 prices) EMC = C + (v 1 P1Q + v 2 Q)2 If EMC>0, then the firm should drill Example 1. If =110, Q1=1, Q2=2, u1= 12, u2=12, P=50, Q=10 EMC=C+(u 1PQ +1u PQ2), 2 =10+110(12x1x50+12x2x50) =2.5 EMV<0, the firm should not drill Example 2. If =110, P1=10, P2=50, v1= 45, v2=15, Q=5 EMC=C+(u 1PQ +1u PQ2), 2 =10+110(45x10x5+15x50x5) =1 EMV<0, the firm should not drill Breakeven analysis It implies the EMC < 0 It uses EMC to answer the question as follows: 1. What is the minimum P for an exploration program to breakeven? 2. Maximum cost of drilling to breakeven? 3. Minimum resource quantity to breakeven?
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