A country that does not tax sulfur dioxide (SO2) pollution from electricity generation is considering the introduction of a tax of $3.00 per unit of electricity output.

A country that does not tax sulfur dioxide (SO2) pollution from electricity generation is considering the introduction of a tax of $3.00 per unit of electricity output. The economic advisors to the country estimate the supply and demand curves for electricity as:

Demand: P = 18-QD,

Supply (or marginal private cost): P = 6 + QS,

where QD is the quantity demanded, QS the quantity supplied, and P the price per unit of electricity generation. The country has hired you to provide the following information regarding the electricity market and the proposed tax. For parts (a) – (b), you do not have to consider externalities due to electricity generation.

A) What are the market equilibrium values with no tax?

B) What price and quantity would prevail after the imposition of the tax? What portion of the tax would be borne by buyers and sellers respectively?

Suppose now the country’s health advisor found that SO2 pollution generates negative externalities, and estimated the marginal external cost to be: MEC = 2 Q.

C) Compute the efficient level of electricity generation given the information.

D) Compute the deadweight loss when no tax is imposed.

E) Compute the tax rate necessary to achieve the efficient level of SO2 emissions. Is the above tax ($3 per unit) too low or too high to achieve the efficient smoking level?

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