Question

Suppose an industry facing an inverse demand equation equal to P = 120 - 4Q faces a new pollution control law that shifts its constant marginal cost of production from C1 = 50 to C2 = 68.
a) Compute the competitive market equilibrium price and output before regulation.

b) Compute producer surplus, consumer surplus and social surplus before regulation.

c) Compute the competitive market equilibrium price and output after regulation.
d) Compute producer surplus, consumer surplus and social surplus after regulation. e) (3pts) Compute the social costs of regulation in this industry.

Answer 1

a. Competitive market equilibrium price and output before regulation. At equilibrium, P = MC 120 4Q 50 4Q 120 50 = 70 Q 70/4 17. 5 P 120 4Q P 120 4*17.5 120 70 50 Equilibrium price $50

           Equilibrium quantity = 17.5

b. producer surplus, consumer surplus and social surplus before regulation Producer surplus = 0 MC 50 and it is constant. Therefore, producer surplus is zero Consumer surplus = 2 * 17.5* (120 50) Consumer surplus = 2* 17.5 * 70 = $612.50 Total surplus consumer surplus + producer surplus Total surplus $612.50 c. Competitive market equilibrium price and output after regulation Equilibrium is attained at the point where P = MC New MC 68 120 4Q 68 4Q 120 68 =52 Q 52/4 13

d. Compute producer surplus, consumer surplus and social surplus after regulation Producer surplus = $0 because of constant marginal cost Consumer surplus = 2* 13* (120- 68) Consumer surplus = 2 * 13 * 52 $338 Total surplus consumer surplus + producer surplus Total surplus $338 e. Social costs of regulation Decrease in total surplus is the social cost of regulation Social cost 612.50 338 274.50 Therefore social cost of regulation is $274..50