Operational Cost And Market Equilibrium Of Punggol Power Co.

Fixed Cost

Introduction:

This report is aimed to discuss the Punggol Power Co. (PPC) operational cost component along with forecasting the equilibrium quantity and price of their product considering the different market conditions. In a structured way the report aims to discuss the different definition of the cost components and show how they are derived for the PPC. As per the given information, PPC have two electricity generation plant that can produce 15,000 kWh of power through the oil fuel and apart from this it has a 5,000 kWh electricity production plant that can generate power with the natural gas. Under unlimited supply of oil and natural gas, this report will construct the different production cost and equilibrium cost and quantity structure of the firm. It is also known that the firm can supply more than its capacity through purchasing the power from other electricity supplier at higher price. Considering this situation, the report will portray the marginal cost, fixed cost and total cost function of the firm. 

It is the amount of firm’s expenditure which is fixed irrespective of its production level and it do not change with the change in the output level (Borenstein, 2016). Fixed cost remain unaltered in case of shutting down of the firm. Thus, it is one of the main component of the total cost function, and with depending upon the scale of operation of the firm, fixed cost, tends to rise (Khodabakshi & Aryavash, 2014). For instance, if the fixed cost is being generated for a car manufacturing firm, then it can be seen that the fixed cost is comparatively higher than a small business owing to the scale of its operation. Cost of building manufacturing unit, maintain the labour force and inventory along with the depreciation of the inventory, fixed cost function tends to rise for the different firm (Zakeri & Syri, 2015). As the example of the fixed cost, purchasing or leading of the capital equipment, change of business rate implied by the business authorities, cost of employing workers and salary of the staff is considered as the example of the fixed cost (Van et al., 2016).

Considering the case of the PPC firm, it can be seen that it has fixed cost in terms of depreciation of the different production unit and management. That means, the firm will incur the cost of depreciation in its different production unit and management unit irrespective of its production and it is fixed in terms of monetary terms. PPC will face fixed depreciation cost in its fuel oil plant by $1,500 and when it comes to the natural gas plant, then the cost of depreciation will be $1,000. Considering the fixed cost of management, PPC incur a cost of $2,000.

Thus, the fixed cost function of the PPC will be as follows:

Fixed cost =

Depreciation cost of fuel oil plant + Depreciation cost of natural gas plant + Managerial cost

Considering the amount of cost incurred under these heads, total fixed cost of the firm is as follows:

Total Cost

Fixed cost =$1500+ $1000 + $ 2000

     = $4,500

Thus, as per the above derivation, it can be seen that, the fixed cost of the firm is $4,500.

Total cost of a firm defines the total economic cost of production that a firm incur due to producing goods or services (Li et al., 2018). Total cost is made of the two distinct components, which are variable cost and the fixed cost. As mentioned above, fixed cost is the amount of the economic cost that a firm occur due to its operation irrespective of the level of output and contrary to this, Variable cost is the amount of the cost of the production that alters with the change in the level of the output (Jara et al., 2017). Variable cost can be defines as the change in the proportionate cost due to the change in the business process.

Considering the case of the PPC, it can be seen that the firm has supply at different range from its 3 energy production plants and it can achieve any amount of supply of power from the other producers at higher cost, total cost function of the firm will be as follows:

Total cost = 4500 + C (Q₁) + C (Q₂) —- (i)

Total cost = 4500 + C (Q₃) —– (ii)

[Where, 4500 is the fixed cost and the rest part defines the variable cost]

Cost function of the firm is linear in nature because it can produce whatever amount of demand is present in the market (Robert & Gosselin, 2014). In addition to this, from the cost function, it can be seen that the firm has two cost function due to its operational structure, where it can produce 20,000 kWh of power from its own production plants and can sell higher output from the point where, it can buy power from the other producers (Sarkar et al., 2015). First cost function defines the cost of producing with the own power house and the second cost function defines the cost of producing utilising all the source of the power generation.

It is one of the essential component of the cost structure of the firm that defines the economies of scale of the firm (Nyers & Komuves, 2015). When it comes to the financial performance analysis of the firm, then marginal cost determines the price of the product. In other words, marginal cost is the opportunity cost of production of producing one another unit of good or service that the firm is producing (Park et al., 2016). If the cost function is C, then the marginal cost function of a firm is the first derivative of the cost function that determine the cost of each additional unit of producing a good or service (Sesmero et al., 2016). Under different market situation, marginal cost curve acts as the price determiner. In case of the perfect competition, marginal cost determine the price of the output and acts as the supply curve; when it comes to the monopoly, then the output is decided at such place, where the marginal cost intersect with the average revenue curve (Rifkin, 2014).

Marginal Cost

Marginal cost function of the PPC is as follow:

dTC/dQ [≤ 15000] = 0.15

dTC/dQ [15000 ≤ Q ≤ 20000] = 0.20

dTC/dQ [≤ 25000] = 0.30  

Considering the case of the PPC, it can be seen that the marginal cost of the firm is reducing with rise in production depicting as the firm produce more it gains economies of scale from the same 

From the above figure, marginal cost of the PPC firm in case of production range from 0 to 25,000 can be observed. As the production of the firm reaches from 0 to 2000 kWh, marginal cost becomes higher and with higher output it eventually starts to fall depicting the fact that the firm will gain economies of scale (Frischmann & Hogendorn, 2015). 

If the demand of electricity if given by the P = 2 – 0.0001Q, then the equilibrium output and the price level can be determined through the profit maximisation process considering the Marginal revenue = Marginal cost = P under the perfect competition scenario. 

As it is known from the equilibrium condition of the perfectly competitive market, it can be seen that price is equal to the marginal cost and equilibrium price and output occurs at that place, where the price equates with the marginal cost. From the analysis, it can be seen that, equilibrium price for the PPC would be 0.2$/kWh and the optimal output level will be 18000 kWh of power.

Conclusion:

From the above analysis it can be seen that the firm has linear total cost function where it can produce with three different power houses and the marginal cost reduces depicting the economies of scale of the firm. In addition to this it can be seen that the firm faces loss with production beyond 20000 kWh and it can maximise its profit through producing 17000 unit of output.

Reference:

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