In the northeast United States and in eastern
Canada, many people heat their houses with heating oil. Imagine you are one of
these people, and you are expecting a cold winter, so you are planning your
heating oil requirements for the season. The current price is $2.25 per US
gallon, but you think that in six months, when you’ll need the oil, the price
could be $3.00, or it could be $1.50.
you need 350 gallons to survive the winter, how much difference does the
potential price variance make to your heating bills?
B. If your friend Tom is running a heating oil
business, and selling 100,000 gallons over the winter season, how does the
price variance affect Tom?
one of you benefits from the price increase? Which of you benefits from price
are two strategies you can use to reduce the risk you face? Could you make an
agreement with Tom to mitigate your risk?
Assuming you are both risk-averse, does
such an agreement make you both better off?