Self Test
Allocating Fossil Fuel
Production Over Time and Oil Leasing
Created by Alex Lombardia, Benoit Gervais, Tsepho
Falatsa, Kehinde Ogunsekan, Tyler Hodge, and Sofia Morales.
Click on True or False to test your knowledge
of the chapter.
1. True False. All
economic decisions can be analyzed with static modeling accurately.
2. True False. The R/P
(reserve over production) ratio gives a measure of how long current proved
reserves will last if current production continues.
3. True False. If an oil
R/P ratio = 15, it indicates that the country will certainly run out of oil in
15 years.
4. True False. The countries with largest oil and gas reserves are Saudi Arabia,
Iraq and Kuwait.
5. True False. Maximizing the value of
production of nonrenewable reserves in a competitive two time period world with
no costs can be solved using a Lagrange multiplier method. The solution will
show that in a competitive model with no cost, price needs to go up at the
interest rate (P1 = (1+r)P0).
6. True False. Let demand, P(Q), represents social benefits, R be total reserves
of a fixed energy source, r be the interest rate, and marginal costs are
zero. Then price going up at the
interest rate maximizes social welfare.
reserves
= 100,
income
(Y) = 70 and does not grow,
interest
rate (r) = 10%,
and
MC = 0,
then optimal use of resources over two time periods
will be Q0 = 56.67 and Q1 = 43.33 and net present value
of reserves = 40,000.
7. True False. If demand is Qd = 120 - 1/3 P + Y,
reserves
= 100,
income
(Y) = 70 and does not grow,
interest
rate (r) = 10%,
and
MC = 0,
then optimal use of resources over two time periods
will be Q0 = 56.67 and Q1 = 43.33 and net present value
of reserves = 40,000.
8. True False. In a two period model with fixed reserves, if the interest rate increases, production will be delayed to the second period.
9. True False. In the two period model from above,
Qd
= 120 - 1/3 P + Y,
R =
100,
income
(Y) = 70 and does not grow,
interest
rate (r) = 10%,
and
MC = 0, and
optimal output in each period was Q1 =
43.33 and Q0 = 56.67.
If reserves, R, change from 100 to 150 for
the model, then production will in increase in both period and Q0 =
80.48 and Q1 = 69.52.
10. True False. If income increases the same amount in both
periods for a two period model with fixed reserves, production will be increased
in both periods, but by a greater amount in the second period.
11. True False. In a two period model from above,
Qd
= 120 - 1/3 P + Y,
R =
100,
income
(Y) = 70 and does not grow,
interest
rate (r) = 10%,
and
MC = 0, and
optimal output in each period was Q1 =
43.33 and Q0 = 56.67.
Now let total costs TC = 50Q. Since marginal costs are constant, optimal
output will not change.
12. True False. In a two period model from
above,
Qd
= 120 - 1/3 P + Y,
R =
100,
income
(Y) = 70 and does not grow,
interest
rate (r) = 10%,
and
TC = 50Q, and
optimal output in each
period was Q0 = 55.87 and Q1 = 44.13.
Now if the market is monopolistic instead of
competitive, then production will be delayed to the second period and Q0
= 52.14 and Q1 = 47.85.
13. True False. When the interest rate
goes to infinity, you should behave as you would in a static market.
14. True False. New technologies in several areas of the oil and
gas industry are likely to have a great impact on production costs in the near
future.
15. True False. The “rule of capture”
encourages efficient use of oil resources and is a good example of well-defined
property rights, leading to welfare maximization.
16. True False. A dynamically optimizing competitive private
market, with no externalities and well
defined property rights, will produce where social welfare is maximized.
17. True False. The first order conditions for competitive and
monopoly markets with fixed resources are different in both the static and
dynamic optimization.
18. True False. Bonus bidding is favored
by economists because it does not distort the production profile.
19. True False. Work bidding is used by
governments that want to develop their resources at a very slow pace.
20. True False. The winner’s curse
describes the paradox of some resource rich countries that under perform in
comparison with some resource poor countries.
21. True False. Concessions and production sharing are two
different types of economic agreement between governments and companies that
have very different economic impacts.
22. True False. A profit tax (tp = 8%) leaves the optimal
use of a resource over two time periods the same.
23. True False. An ad valorem tax on a nonrenewable resource would
not change the production profile.
24.
True False. Iraq has the highest proven
oil and gas Reserve/Production ratio in the world because they value the future
more (P1 >Po(1+r)) than the current period. (i.e. their current production rate is low
because they think that the oil in the ground is worth more than the money in
the bank.
25. True False. Governments can unitize an oil field as a way of
alleviating a monopolistic market imperfection.
26. True False. In a two period model from above,
Qd
= 120 - (1/3)P + Y,
R =
100,
income
(Y) = 70 and does not grow,
interest
rate (r) = 10%,
and
MC = 0, and
optimal output in each period was Q1 =
43.33 and Q0 = 56.67.
Now if a backstop is introduced with a backstop
price of $350, then production will be Q0 = 83 and Q1 =
73.33 and the amount of backstop consumed in the second period is 56.33.
27. True False. In a dynamic multiperiod model,
Qd
= 120 - 1/3 P + Y,
R =
100,
income
(Y) = 70 and does not grow,
interest
rate (r) = 10%,
and
MC = 0
And reserves would last 5 periods before they were exhausted.
28. True False. Assume that producers dynamically optimize in a two
period model from above,
Qd
= 120 - (1/3)P + Y,
R =
100,
income
(Y) = 70 and does not grow,
interest
rate (r) = 10%,
and
MC = 0, and
optimal output in each period was Q1 =
43.33 and Q0 = 56.67 at price Po = $400 and P1
= $440. If a price control of $308 is
passed, Po = $308 and P1 = $308.