More evidence that firms operate when average total cost > price > average variable cost and shut down when price < average variable cost

More Cuts Loom as Oil Nears $25
by: Erin Ailworth and Bradley Olson
Feb 12, 2016
Click here to view the full article on WSJ.com

TOPICS: Oil Markets, Production

SUMMARY: As crude prices slide toward $25 a barrel, many oil companies have little choice but to start making the steep cost cuts they have avoided up until now, jettisoning every well that can't break even or isn't needed to keep the lights on.

CLASSROOM APPLICATION: In the context of this oil case, students can evaluate two economic principles: the shut-down point and a firm's optimal level of employment. Students can evaluate the reason why oil producers are operating despite losses and the reason why the producers are laying off workers.

QUESTIONS: 
1. (Introductory) U.S. and Canadian producers are losing at least $350 million a day at current prices, according to an AlixPartners analysis. Should all producers that are losing money be shutting down operations? Characterize the oil price at which a producer should shut down.

2. (Advanced) Why are oil companies laying off workers? Use the wage rate and the concept of the marginal revenue product of labor for a given type of job in answering the question.

3. (Advanced) John England, vice chairman of energy for Deloitte LLP, is advising energy clients trying to stave off bankruptcy to go ahead and make the steep cost cuts they would have to if forced to declare. How does the potential prospect of bankruptcy affect a firm's decision to make steep cuts in costs?

Reviewed By: James Dearden, Lehigh University