Steel production is a dirty business. It is a significant contributor to local air quality problems, and it accounts for roughly 5% of greenhouse gas emissions globally. Two tons of carbon dioxide are emitted for each single ton of steel produced. Despite efforts to innovate, there is no viable technology for reducing the emissions intensity of steel production; the only way to reduce carbon pollution in this industry is to reduce steel production.

Imagine that the steel market is characterized as follows

Marginal costs:MC(Q) = 1.25Q

Marginal benefits:MB(Q) = 27−Q

Marginal damages:MD(Q) = 0.25Q

(A) Draw a graph containing MC(Q),MB(Q), and, SMC(Q) =MC(Q) +(Q). Concisely

describe what each of these functions measure in the context of steel production and consumption. 

Imagine that this market is perfectly competitive. Equilibrium steel production is then defined by

MC(Q∗) =MB(Q*).

(B) So what actually happens in this market, in equilibrium? I.e., what is (Q∗, P∗)? [2 points]

(C) Label (on a graph) and calculate the consumer surplus (CS), producer surplus (PS), and total damages (TD). 

(D) What quantity (Q∗∗) maximizes total net benefits in this market? How do you know? Calculate the deadweight loss in the market without any government intervention (i.e., (Q∗, P∗)).

(E) Explain how incentives in the free (i.e., no-intervention) market cause a deviation from the outcome that would have maximized total net benefits. 

(F) Holding constant (P∗, Q∗), how would you expect Q∗∗to change if: (a) demand were more inelastic; (b) marginal damages were larger? 

U.S. demand for steel is met by both domestic supply (≈70%) and imports (≈30%). The Trump Administration implemented a tariff on all steel imports beginning in June of last year, with the goal of supporting the domestic steel industry. One effect of this policy change was a higher price of steel in the U.S. Imagine, for simplicity, that this price change was realized through an upward shift in the marginal cost curve

MC1(Q) = 1.25Q+ 2.25

(G) Calculate the change in total damages caused by this shift in the marginal cost curve. 

(H) What percentage of the total lost surplus (CS+PS) from this change comes from a reduction in consumer surplus? 

(I) Compare (in terms of magnitude) the ratio of the lost surpluses (∆CS/∆PS) to (the absolute value of) the ratio of the slopes (slopeD/slopeS)). 

Answer rating: 100% (QA)

A Graph description MCQ Marginal Cost curve represents the additional cost of producing each additional unit of steel It is upward sloping indicating that as steel production increases the marginal co... View the full answer