A state-owned electricity corporation in a developing country is considering the construction of a new coal fired power station. The project will increase domestic supply of electricity by 10 million megawatt hours per annum (MWh p.a.). Currently, 40 million MWh are supplied and consumed in the country each year.

The average sale price of electricity prior to the new project was US$80.00 per MWh. In order to clear the market after the new power station comes on stream, it is calculated that the price of electricity will need to fall to US$75.00 per MWh. At this lower price, some small and older existing power stations will become uneconomic. The electricity generating authority is expected to decommission some of these units which will reduce supply by 2.5 million MWh p.a.

a)Calculate the total economic benefits of the proposed project using both a diagram and the Harberger equation (assume that demand and supply curves are straight lines and that any shifts are parallel).

b) Re-calculate the total economic benefits of the proposed project considering that the government imposes a sales tax of 10% on electricity prices and that this sales tax will also apply after the project begins generation. Again, use both a diagram and the Harberger equation to make your calculations.

c) Conduct a benefit-cost analysis of the project using your answer to ii) above as a measure of the benefits that the project provides and which considers the following costs (all in millions of US$); and assumes that the project has an operating life of 30 years:

Capital costs (land purchase, construction, machinery, etc.), the power station will take 5 years to build with power generation starting in Year 6;